UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q-A
(Amendment No. 1)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
Commission file number000-04217
ACETO CORPORATION
(Exact name of registrant as specified in its charter)
| New York | 11-1720520 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |
| 4 Tri Harbor Court, Port Washington, NY 11050 | ||
| (Address of principal executive offices) (Zip Code) | ||
(516) 627-6000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yesx No¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every interactive data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yesx No¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer", "smaller reporting company", and "emerging growth company" in Rule 12b-2 of the Exchange Act. Check one:
| Large accelerated filer | x | Accelerated filer | ¨ | |
| Non-accelerated filer | ¨ | (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
| Emerging growth company | ¨ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes¨ Nox
The registrant had 30,788,044 shares of common stock outstanding as of May 1, 2018.
Explanatory Note
(all dollar amounts in this Explanatory Note are expressed in thousands)
Aceto Corporation (the “Company”)is filing this Amendment No. 1 (“Amendment No. 1”) to its Quarterly Report on Form 10-Q for the quarter ended March 31, 2018, which was filed with the Securities and Exchange Commission (“SEC”) on May 7, 2018 (the “Original Filing”), to amend and restate the Company’s unaudited consolidated condensed financial statements and related notes for the three and nine months ended March 31, 2018 and 2017, as discussed below and in Notes 2 and 12 to the accompanying restated consolidated condensed financial statements, as well as to amend certain other Items within the Original Filing as listed in “Items Amended in this Filing” below, as a result of the restatement of the Company’s consolidated condensed financial statements. Certain reclassifications between trade receivables and accrued expenses to the June 30, 2017 consolidated balance sheet, which have been reflected in the Company’s Annual Report on Form 10-K for the year ended June 30, 2018 are not reflected in the June 30, 2017 consolidated balance sheet presented herein.
Background of the Restatement
On September 26, 2018, the Audit Committee (the “Audit Committee”) of the Board of Directors of the Company, in consultation with management and the Company's independent registered public accounting firm, BDO USA, LLP (“BDO”), determined that the Company’s unauditedconsolidated condensedfinancial statements for the three and nine months ended March 31, 2018 (the “Relevant Financial Statements”) incorrectly accounted for a valuation allowance related to deferred tax assets and should be restated to reflect this allowance (the “Restatement”). This incorrect valuation allowance has no effect on the Company's cash position or operating expenses and is solely related to the appropriate timing of the recording of a valuation allowance reserved against U.S. deferred tax assets.
At the time of the March 31, 2018 Form 10-Q filing, the Company believed that the carrying value of its deferred tax assets was appropriate based on its view that it was more likely than not that this deferred tax asset would be realized in future periods. In preparing its consolidated financial statements for the year ended June 30, 2018, the Company determined, in consultation with BDO, based on management's review of current and historical performance, internal projections and industry data and applicable accounting literature, that it should recognize a valuation allowance equal to the entire carrying value of the Company’s U.S. deferred tax assets. However, upon further review of the negative and positive objective evidence and applicable accounting literature, the Company determined, in consultation with BDO, that a full valuation allowance on domestic net deferred tax assets should have been recorded as of the end of its third fiscal quarter rather than as of the end of its fourth fiscal quarter. As a result, the Company has determined to record a valuation allowance of approximately $71,350 on its U.S. deferred tax assets at March 31, 2018.
The impact of this Restatement on the Company’s consolidated statements of operations for the three and nine months ended March 31, 2018 is to increase income tax expense and net loss by approximately $71,350.
| As reported | Adjustment | As restated | ||||||||||
| For the quarter ended March 31, 2018 | ||||||||||||
| Loss before income taxes | $ | (263,037 | ) | $ | - | $ | (263,037 | ) | ||||
| Income tax (benefit) provision | (66,402 | ) | 71,350 | 4,948 | ||||||||
| Net loss | (196,635 | ) | (71,350 | ) | (267,985 | ) | ||||||
| Loss per diluted share | $ | (5.57 | ) | $ | (2.02 | ) | $ | (7.59 | ) | |||
| As reported | Adjustment | As restated | ||||||||||
| For the nine months ended March 31, 2018 | $ | |||||||||||
| Loss before income taxes | $ | (261,398 | ) | - | $ | (261,398 | ) | |||||
| Income tax (benefit) provision | (51,353 | ) | 71,350 | 19,997 | ||||||||
| Net loss | (210,045 | ) | (71,350 | ) | (281,395 | ) | ||||||
| Loss per diluted share | $ | (5.97 | ) | $ | (2.03 | ) | $ | (8.00 | ) | |||
For additional information regarding the impact of the Restatement on the Company’s financial statements, see Note 2 of the notes to the Company’s consolidated financial statements.
| 2 |
On September 26, 2018, the Audit Committee concluded that the Relevant Financial Statements and related disclosures included in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2018, should no longer be relied upon. This Amendment No. 1 reflects the Restatement. The Restatement has no effect on the Company’s consolidated balance sheet as of June 30, 2018 and consolidated statement of operations for the year ended June 30, 2018, which financial statements were filed on September 28, 2018 with the Company’s Annual Report on Form 10-K for the year ended June 30, 2018. The Annual Report reflected the results of the Restatement in Note 20 to the Company’s consolidated financial statements, entitled “Unaudited Quarterly Financial Data.”
Internal Control Considerations
The Company’s management determined that there was a control deficiency in its internal control that constitutes a material weakness, as discussed in Part I — Item 4 of this Amendment No. 1. A material weakness is a deficiency, or combination of control deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim consolidated financial statements will not be prevented or detected on a timely basis.
Items Amended in This Filing
For the convenience of the reader, this Amendment No. 1 sets forth the Original Filing, as modified and superseded where necessary to reflect the Restatement. The following items have been amended as a result of, and to reflect, the Restatement:
| · | Part I — Item 1. Financial Statements; |
| · | Part I — Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations; and |
| · | Part I — Item 4. Controls and Procedures. |
In accordance with applicable SEC rules, this Amendment No. 1 includes new certifications required by Rule 13a-14 under the Securities and Exchange Act of 1934 (“Exchange Act”) from our Chief Executive Officer and Chief Financial Officer dated as of the date of filing of this Amendment No. 1.
Except for the items noted above, no other information included in the Original Filing is being amended or updated by this Amendment No. 1. This Amendment No. 1 continues to describe the conditions as of the date of the Original Filing, and, except as contained herein, the Company has not updated or modified the disclosures contained in the Original Filing. Accordingly, this Amendment No. 1 should be read in conjunction with the Company’s filings made with the SEC subsequent to the filing of the Original Filing, including the Company’s Annual Report on Form 10-K.
| 3 |
ACETO CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10Q-A FOR THE PERIOD ENDED MARCH 31, 2018
TABLE OF CONTENTS
| 4 |
CAUTIONARY STATEMENT RELATING TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Quarterly Report on Form 10-Q/A contains forward-looking statements as that term is defined in the federal securities laws. The events described in forward-looking statements contained in this Quarterly Report may not occur. Generally, these statements relate to our business plans or strategies, projected or anticipated benefits or other consequences of our plans or strategies, financing plans, projected or anticipated benefits from acquisitions that we may make, or projections involving anticipated revenues, earnings or other aspects of our operating results or financial position, and the outcome of any contingencies. Any such forward-looking statements are based on current expectations, estimates and projections of management. We intend for these forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements. Words such as “may,” “will,” “expect,” “believe,” “anticipate,” “project,” “plan,” “intend,” “estimate,” and “continue,” and their opposites and similar expressions are intended to identify forward-looking statements. We caution you that these statements are not guarantees of future performance or events and are subject to a number of uncertainties, risks and other influences, many of which are beyond our control, that may influence the accuracy of the statements and the projections upon which the statements are based. Factors that may affect our results include, but are not limited to the risks and uncertainties discussed in Item 1A of this Quarterly Report on Form 10-Q/A, the Company’s Annual Report on Form 10-K for the year ended June 30, 2017, as amended and other filings.
Any one or more of these uncertainties, risks and other influences could materially affect our results of operations and whether forward-looking statements made by us ultimately prove to be accurate. Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether from new information, future events or otherwise.
| 5 |
ACETO CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per-share amounts)
March 31, 2018 (as | June 30, 2017 | |||||||
| (unaudited) | ||||||||
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 62,032 | $ | 55,680 | ||||
| Investments | 3,059 | 2,046 | ||||||
| Trade receivables, less allowance for doubtful accounts (March 31, 2018, $805; June 30, 2017, $485) | 260,168 | 260,889 | ||||||
| Other receivables | 15,771 | 12,066 | ||||||
| Inventory | 141,669 | 136,387 | ||||||
| Prepaid expenses and other current assets | 4,942 | 3,941 | ||||||
| Deferred income tax asset, net | - | 546 | ||||||
| Total current assets | 487,641 | 471,555 | ||||||
| Property and equipment, net | 14,002 | 10,428 | ||||||
| Property held for sale | 6,250 | 7,152 | ||||||
| Goodwill | 1,939 | 236,970 | ||||||
| Intangible assets, net | 241,513 | 285,081 | ||||||
| Deferred income tax asset, net | - | 19,453 | ||||||
| Other assets | 9,846 | 7,546 | ||||||
| TOTAL ASSETS | $ | 761,191 | $ | 1,038,185 | ||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
| Current liabilities: | ||||||||
| Current portion of long-term debt | $ | 190,723 | $ | 14,466 | ||||
| Accounts payable | 125,083 | 90,011 | ||||||
| Accrued expenses | 119,389 | 118,328 | ||||||
| Total current liabilities | 435,195 | 222,805 | ||||||
| Long-term debt, net | 128,697 | 339,200 | ||||||
| Long-term liabilities | 63,623 | 61,449 | ||||||
| Environmental remediation liability | 383 | 2,339 | ||||||
| Deferred income tax liability | 1,261 | 7,325 | ||||||
| Total liabilities | 629,159 | 633,118 | ||||||
| Commitments and contingencies (Note 8) | ||||||||
| Shareholders’ equity: | ||||||||
| Preferred stock, 2,000 shares authorized; no shares issued and outstanding | - | - | ||||||
| Common stock, $.01 par value, 75,000 shares authorized; 30,839 and 30,094 shares issued and outstanding at March 31, 2018 and June 30, 2017, respectively | 308 | 301 | ||||||
| Capital in excess of par value | 221,253 | 214,198 | ||||||
| Retained (deficit) earnings | (91,704 | ) | 195,680 | |||||
| Accumulated other comprehensive income (loss) | 2,175 | (5,112 | ) | |||||
| Total shareholders’ equity | 132,032 | 405,067 | ||||||
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 761,191 | $ | 1,038,185 | ||||
See accompanying notes to condensed consolidated financial statements and accountants’ review report.
| 6 |
ACETO CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited and in thousands, except per-share amounts)
| Nine months Ended | ||||||||
| March 31, | ||||||||
| 2018 | 2017 | |||||||
| (as restated) | ||||||||
| Net sales | $ | 542,482 | $ | 443,698 | ||||
| Cost of sales | 440,833 | 339,735 | ||||||
| Gross profit | 101,649 | 103,963 | ||||||
| Selling, general and administrative expenses | 87,241 | 75,614 | ||||||
| Impairment charges | 256,266 | - | ||||||
| Research and development expenses | 6,208 | 4,998 | ||||||
| Operating (loss) income | (248,066 | ) | 23,351 | |||||
| Other (expense) income: | ||||||||
| Interest expense | (15,443 | ) | (10,223 | ) | ||||
| Interest and other income, net | 2,111 | 1,230 | ||||||
| (13,332 | ) | (8,993 | ) | |||||
| (Loss) income before income taxes | (261,398 | ) | 14,358 | |||||
| Income tax provision | 19,997 | 4,949 | ||||||
| Net (loss) income | $ | (281,395 | ) | $ | 9,409 | |||
| Basic (loss) income per common share | $ | (8.00 | ) | $ | 0.30 | |||
| Diluted (loss) income per common share | $ | (8.00 | ) | $ | 0.30 | |||
| Weighted average shares outstanding: | ||||||||
| Basic | 35,162 | 31,453 | ||||||
| Diluted | 35,162 | 31,792 | ||||||
See accompanying notes to condensed consolidated financial statements and accountants’ review report.
| 7 |
ACETO CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited and in thousands, except per-share amounts)
| Three months Ended | ||||||||
| March 31, | ||||||||
| 2018 | 2017 | |||||||
| (as restated) | ||||||||
| Net sales | $ | 185,998 | $ | 190,128 | ||||
| Cost of sales | 158,302 | 147,809 | ||||||
| Gross profit | 27,696 | 42,319 | ||||||
| Selling, general and administrative expenses | 28,029 | 26,519 | ||||||
| Impairment charges | 256,266 | - | ||||||
| Research and development expenses | 2,471 | 2,607 | ||||||
| Operating (loss) income | (259,070 | ) | 13,193 | |||||
| Other (expense) income: | ||||||||
| Interest expense | (5,040 | ) | (5,321 | ) | ||||
| Interest and other income, net | 1,073 | 640 | ||||||
| (3,967 | ) | (4,681 | ) | |||||
| (Loss) income before income taxes | (263,037 | ) | 8,512 | |||||
| Income tax provision | 4,948 | 2,924 | ||||||
| Net (loss) income | $ | (267,985 | ) | $ | 5,588 | |||
| Basic (loss) income per common share | $ | (7.59 | ) | $ | 0.16 | |||
| Diluted (loss) income per common share | $ | (7.59 | ) | $ | 0.16 | |||
| Weighted average shares outstanding: | ||||||||
| Basic | 35,304 | 34,769 | ||||||
| Diluted | 35,304 | 35,121 | ||||||
See accompanying notes to condensed consolidated financial statements and accountants’ review report.
| 8 |
ACETO CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(unaudited and in thousands)
Nine months Ended March 31, | Three months Ended March 31, | |||||||||||||||
| 2018 | 2017 | 2018 | 2017 | |||||||||||||
| (as restated) | (as restated) | |||||||||||||||
| Net (loss) income | $ | (281,395 | ) | $ | 9,409 | $ | (267,985 | ) | $ | 5,588 | ||||||
| Other comprehensive (loss) income: | ||||||||||||||||
| Foreign currency translation adjustments | 5,167 | (2,201 | ) | 1,941 | 947 | |||||||||||
| Change in fair value of interest rate swaps | 2,120 | (249 | ) | 1,138 | (249 | ) | ||||||||||
| Comprehensive (loss) income | $ | (274,108 | ) | $ | 6,959 | $ | (264,906 | ) | $ | 6,286 | ||||||
See accompanying notes to condensed consolidated financial statements and accountants’ review report.
| 9 |
ACETO CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited and in thousands)
Nine months Ended March 31, | ||||||||
| 2018 | 2017 | |||||||
| (as restated) | ||||||||
| Operating activities: | ||||||||
| Net (loss) income | $ | (281,395 | ) | $ | 9,409 | |||
| Adjustments to reconcile net (loss) income to net cash provided by operating activities: | ||||||||
| Depreciation and amortization | 24,608 | 15,301 | ||||||
| Amortization of debt issuance costs and debt discount | 4,603 | 4,355 | ||||||
| Amortization of deferred financing costs | 833 | 300 | ||||||
| Provision for doubtful accounts | 305 | (18 | ) | |||||
| Non-cash stock compensation | 6,442 | 5,239 | ||||||
| Deferred income taxes | 11,714 | 627 | ||||||
| Environmental charge | 902 | 903 | ||||||
| Earnings on equity investment in joint venture | (1,990 | ) | (1,558 | ) | ||||
| Contingent consideration | (2,505 | ) | - | |||||
| Impairment charges | 256,266 | - | ||||||
| Changes in assets and liabilities: | ||||||||
| Trade accounts receivable | 2,573 | (14,839 | ) | |||||
| Other receivables | (3,662 | ) | 1,664 | |||||
| Inventory | (3,102 | ) | (3,778 | ) | ||||
| Prepaid expenses and other current assets | (927 | ) | (424 | ) | ||||
| Other assets | (2,202 | ) | 215 | |||||
| Accounts payable | 34,224 | 18,857 | ||||||
| Accrued expenses and other liabilities | 9,728 | (4,702 | ) | |||||
| Net cash provided by operating activities | 56,415 | 31,551 | ||||||
| Investing activities: | ||||||||
| Payment for net assets of business acquired | - | (270,000 | ) | |||||
| Purchases of investments | (2,880 | ) | (1,824 | ) | ||||
| Sales of investments | 1,867 | 775 | ||||||
| Payments for intangible assets | (779 | ) | (3,077 | ) | ||||
| Purchases of property and equipment, net | (4,677 | ) | (1,386 | ) | ||||
| Net cash used in investing activities | (6,469 | ) | (275,512 | ) | ||||
| Financing activities: | ||||||||
| Payment of cash dividends | (5,924 | ) | (5,944 | ) | ||||
| Proceeds from exercise of stock options | 595 | 550 | ||||||
| Excess tax benefit on stock option exercises and restricted stock | - | 551 | ||||||
| Borrowings of bank loans | - | 265,000 | ||||||
| Payment for deferred financing costs | - | (5,407 | ) | |||||
| Repayment of bank loans | (39,398 | ) | (16,898 | ) | ||||
| Net cash (used in) provided by financing activities | (44,727 | ) | 237,852 | |||||
| Effect of exchange rate changes on cash | 1,133 | (757 | ) | |||||
| Net increase (decrease) in cash | 6,352 | (6,866 | ) | |||||
| Cash and cash equivalents at beginning of period | 55,680 | 66,828 | ||||||
| Cash and cash equivalents at end of period | $ | 62,032 | $ | 59,962 | ||||
Non-Cash Item
In connection with the acquisition of certain products and related assets of entities referred to herein as Citron and Lucid, approximately 5,122 shares of Aceto common stock with a fair value of $90,400, to be issued beginning on December 21, 2019, is a non-cash item and is excluded from the Condensed Consolidated Statement of Cash Flows during the nine months ended March 31, 2017.
See accompanying notes to condensed consolidated financial statements and accountants’ review report
| 10 |
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
(1) Basis of Presentation
The condensed consolidated financial statements of Aceto Corporation and subsidiaries (“Aceto” or the “Company”) included herein have been prepared by the Company and reflect all adjustments (consisting solely of normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for all periods presented. Interim results are not necessarily indicative of results which may be achieved for the full year.
The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses reported in those financial statements and the disclosure of contingent assets and liabilities at the date of the financial statements. These judgments can be subjective and complex, and consequently actual results could differ from those estimates and assumptions. The Company’s most critical accounting policies relate to revenue recognition; allowance for doubtful accounts; inventory; goodwill and other indefinite-life intangible assets; long-lived assets; environmental matters and other contingencies; income taxes; stock-based compensation; and purchase price allocation.
These condensed consolidated financial statements do not include all disclosures associated with consolidated financial statements prepared in accordance with GAAP. Accordingly, these statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended June 30, 2017, as amended (the “2017 10-K”).
(2) Restatement of Previously Issued Financial Statements
As previously disclosed, the Company determined that it incorrectly accounted for a valuation allowance related to U.S. net deferred tax assets. At the time of the March 31, 2018 Form 10-Q filing, the Company believed that the carrying value of its deferred tax assets was appropriate based on its view that it was more likely than not that this deferred tax asset would be realized in future periods. In preparing its consolidated financial statements for the year ended June 30, 2018, the Company determined, in consultation with BDO USA, LLP (“BDO”), based on management's review of current and historical performance, internal projections and industry data and applicable accounting literature, that it should recognize a valuation allowance equal to the entire carrying value of the Company’s U.S. deferred tax assets. However, upon further review of the negative and positive objective evidence and applicable accounting literature, the Company determined, in consultation with BDO, that a full valuation allowance on domestic net deferred tax assets should have been recorded as of the end of its third fiscal quarter rather than as of the end of its fourth fiscal quarter. As a result, the Company has determined to record a valuation allowance of approximately $71,350 on its U.S. deferred tax assets at March 31, 2018.
As a result, the Company is restating its condensed consolidated financial statements for the three and nine months ended March 31, 2018. The following financial tables reconcile the previously reported amounts to the restated amounts for each condensed consolidated financial statement.
The table below sets forth the condensed consolidated balance sheet, including the balances originally reported, corrections and the as restated balances for March 31, 2018 (in thousands):
| As Reported | Adjustment | As Restated | ||||||||||
| Assets | ||||||||||||
| Deferred income tax asset, net | $ | 70,089 | $ | (70,089 | ) | $ | - | |||||
| Total assets | 831,280 | (70,089 | ) | 761,191 | ||||||||
| Liabilities and Shareholders’ Equity | ||||||||||||
| Deferred income tax liability | - | 1,261 | 1,261 | |||||||||
| Total liabilities | 627,898 | 1,261 | 629,159 | |||||||||
| Retained deficit | (20,354 | ) | (71,350 | ) | (91,704 | ) | ||||||
| Total shareholders’ equity | 203,382 | (71,350 | ) | 132,032 | ||||||||
| Total liabilities and shareholders’ equity | $ | 831,280 | $ | (70,089 | ) | $ | 761,191 | |||||
| 11 |
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
The tables below set forth the condensed consolidated statements of loss, including the balances originally reported, corrections and the as restated balances for the three and nine months ended March 31, 2018 (in thousands, except per share data):
| As Reported | Adjustment | As Restated | ||||||||||
| Three months ended March 31, 2018 | ||||||||||||
| Income tax (benefit) provision | $ | (66,402 | ) | $ | 71,350 | $ | 4,948 | |||||
| Net loss | $ | (196,635 | ) | $ | (71,350 | ) | $ | (267,985 | ) | |||
| Basic loss per common share | $ | (5.57 | ) | $ | (2.02 | ) | $ | (7.59 | ) | |||
| Diluted loss per common share | $ | (5.57 | ) | $ | (2.02 | ) | $ | (7.59 | ) | |||
| As Reported | Adjustment | As Restated | ||||||||||
| Nine months ended March 31, 2018 | ||||||||||||
| Income tax (benefit) provision | $ | (51,353 | ) | $ | 71,350 | $ | 19,997 | |||||
| Net loss | $ | (210,045 | ) | $ | (71,350 | ) | $ | (281,395 | ) | |||
| Basic loss per common share | $ | (5.97 | ) | $ | (2.03 | ) | $ | (8.00 | ) | |||
| Diluted loss per common share | $ | (5.97 | ) | $ | (2.03 | ) | $ | (8.00 | ) | |||
The tables below set forth the condensed consolidated statements of comprehensive income, including the balances originally reported, corrections and the as restated balances for the three and nine months ended March 31, 2018 (in thousands):
| As Reported | Adjustment | As Restated | ||||||||||
| Three months ended March 31, 2018 | ||||||||||||
| Net loss | $ | (196,635 | ) | $ | (71,350 | ) | $ | (267,985 | ) | |||
| Comprehensive loss | $ | (193,556 | ) | $ | (71,350 | ) | $ | (264,906 | ) | |||
| As Reported | Adjustment | As Restated | ||||||||||
| Nine months ended March 31, 2018 | ||||||||||||
| Net loss | $ | (210,045 | ) | $ | (71,350 | ) | $ | (281,395 | ) | |||
| Comprehensive loss | $ | (202,758 | ) | $ | (71,350 | ) | $ | (274,108 | ) | |||
The table below sets forth the condensed consolidated statements of cash flows from operating activities, including the balances originally reported, corrections and the as restated balances for the nine months ended March 31, 2018 (in thousands):
| As Reported | Adjustment | As Restated | ||||||||||
| Nine months ended March 31, 2018 | ||||||||||||
| Net loss | $ | (210,045 | ) | $ | (71,350 | ) | $ | (281,395 | ) | |||
| Deferred income taxes | (80,207 | ) | 91,921 | 11,714 | ||||||||
| Accrued expenses and other liabilities | 30,299 | (20,571 | ) | 9,728 | ||||||||
| Net cash provided by operating activities | 56,415 | - | 56,415 | |||||||||
As indicated above, there was no impact on net cash provided by operating activities as the valuation allowance is a non-cash item. In addition, the restatement had no impact on cash flows from investing activities or financing activities.
| 12 |
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
(3) Business Combinations
On December 21, 2016, wholly owned subsidiaries of Rising Pharmaceuticals, Inc. (“Rising”), a wholly owned subsidiary of Aceto, completed the acquisition of certain generic products and related assets of entities formerly known as Citron Pharma LLC (“Citron”) and its affiliate Lucid Pharma LLC (“Lucid”). Citron was a privately-held New Jersey-based pharmaceutical company focused on developing and marketing generic pharmaceutical products in partnership with leading generic pharmaceutical manufacturers based in India and the United States. Lucid was a privately-held New Jersey-based generic pharmaceutical distributor specializing in providing cost-effective products to various agencies of the U.S. Federal Government including the Veterans Administration and the Defense Logistics Agency. Lucid serviced 18 national contracts with the Federal Government, nearly all of which had 5-year terms.
Aceto and Citron possess complementary asset-light business models, drug development and manufacturing partnerships and product portfolios. The Company believes consistent with its strategy of expanding Rising’s portfolio of finished dosage form generic products through product development partnerships and acquisitions of late stage assets, abbreviated new drug applications (“ANDAs”) and complementary generic drug businesses, this transaction significantly expanded its roster of commercialized products and pipeline of products under development. In addition, the Company believes that this product acquisition greatly enhanced its size and stature within the generic pharmaceutical industry, expanded its partnership network and offers the Company opportunities to realize meaningful cost and tax efficiencies.
At closing, Aceto paid the sellers $270,000 in cash, committed to make a $50,000 unsecured deferred payment that will bear interest at a rate of 5% per annum to the sellers on December 21, 2021 and agreed to issue 5,122 shares of Aceto common stock beginning on December 21, 2019. The product purchase agreement also provides the sellers with a 5-year potential earn-out of up to an additional $50,000 in cash, based on the financial performance of four pre-specified pipeline products that are currently in development. In the third quarter of fiscal 2018, the Company reversed $2,505 of contingent consideration due to management’s evaluation and assessment of the financial performance of these products. As of March 31, 2018, the Company accrued $663 related to this contingent consideration.
Rising formed two subsidiaries to consummate the product acquisition – Rising Health, LLC (which acquired certain products and related assets of Citron) and Acetris Health, LLC (which acquired certain products and related assets of Lucid).
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ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
(4) Stock-Based Compensation
Under the Aceto Corporation 2015 Equity Participation Plan (the “2015 Plan”), grants of stock options, stock appreciation rights, restricted stock, restricted stock units and other stock-based awards (“Stock Awards”) may be offered to employees, non-employee directors, consultants and advisors of the Company, including the chief executive officer, chief financial officer and other named executive officers. The maximum number of shares of common stock of the Company that may be issued pursuant to Stock Awards granted under the 2015 Plan will not exceed, in the aggregate, 4,250 shares. Performance-based awards may be granted, vested and paid based on the attainment of specified performance goals.
Under the Aceto Corporation 2010 Equity Participation Plan (as amended and restated in 2012, the “2010 Plan”), grants of stock options, restricted stock, restricted stock units, stock appreciation rights, and stock bonuses may be made to employees, non-employee directors and consultants of the Company. The maximum number of shares of common stock of the Company that may be issued pursuant to awards granted under the 2010 Plan will not exceed, in the aggregate, 5,250 shares. In addition, restricted stock may be granted to an eligible participant in lieu of a portion of any annual cash bonus earned by such participant. Such award may include additional shares of restricted stock (premium shares) greater than the portion of bonus paid in restricted stock. The restricted stock award is vested at issuance and the restrictions lapse ratably over a period of years as determined by the Board of Directors, generally three years. The premium shares vest when all the restrictions lapse, provided that the participant remains employed by the Company at that time.
During the nine months ended March 31, 2018, the Company granted 490 shares of restricted common stock to its employees that vest over three years and 27 shares of restricted stock to its non-employee directors, which vest over approximately one year. In addition, the Company also issued a target grant of 203 performance-vested restricted stock units, which grant could be as much as 355 units if certain performance criteria and market conditions are met. These performance-vested restricted stock units will cliff vest 100% at the end of the third year following grant in accordance with the performance metrics set forth in the applicable employee performance-vested restricted stock unit grant.
During the year ended June 30, 2017, the Company granted 277 shares of restricted common stock to its employees that vest over three years and 22 shares of restricted common stock to its non-employee directors, which vest over approximately one year as well as 42 restricted stock units that have varying vest dates through July 2017. In addition, the Company also issued a target grant of 160 performance-vested restricted stock units, which grant could be as much as 280 if certain performance criteria and market conditions are met. These performance-vested restricted stock units will cliff vest 100% at the end of the third year following grant in accordance with the performance metrics set forth in the applicable employee performance-vested restricted stock unit grant.
For the three and nine months ended March 31, 2018, the Company recorded stock-based compensation expense of approximately $1,931 and $6,426, respectively, related to restricted common stock and restricted stock units. Included in the $6,426 for the nine months ended March 31, 2018 is $431 in stock-based compensation expense associated with the retirement of a Chief Financial Officer in March 2018 and $2,017 in stock-based compensation expense associated with theseparation of the Company’s former Chief Executive Officer in September 2017. For the three and nine months ended March 31, 2017, the Company recorded stock-based compensation expense of approximately $1,506 and $5,213, respectively, related to restricted common stock and restricted stock units. As of March 31, 2018, the total unrecognized stock-based compensation cost is approximately $7,864.
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ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
(5) Capital Stock
On May 3, 2018, the Company’s Board of Directors declared a quarterly dividend of $0.01 per share which will be paid on June 22, 2018 to shareholders of record as of June 8, 2018.
On February 1, 2018, the Company’s Board of Directors declared a regular quarterly dividend of $0.065 per share which was paid on March 23, 2018 to shareholders of record as of March 9, 2018.
On December 7, 2017, the Company's Board of Directors declared a regular quarterly dividend of $0.065 per share which was paid on December 28, 2017 to shareholders of record as of December 18, 2017.
On August 24, 2017, the Company's Board of Directors declared a regular quarterly dividend of $0.065 per share which was paid on September 21, 2017 to shareholders of record as of September 8, 2017.
On May 4, 2017, the Board of Directors of the Company authorized the continuation of the Company’s stock repurchase program, expiring in May 2020. Under the stock repurchase program, the Company is authorized to purchase up to 5,000 shares of common stock in open market or private transactions, at prices not to exceed the market value of the common stock at the time of such purchase.
The Company is authorized to issue 75,000 shares of Common Stock and 2,000 shares of Preferred Stock. The Board of Directors has authority under the Company’s Restated Certificate of Incorporation to issue shares of preferred stock with voting and other relative rights to be determined by the Board of Directors.
(6) Net (Loss) Income Per Common Share
Basic income per common share is based on the weighted average number of common shares outstanding during the period. Diluted income per common share includes the dilutive effect of potential common shares outstanding. The following table sets forth the reconciliation of weighted average shares outstanding and diluted weighted average shares outstanding:
Nine Months Ended March 31, | Three Months Ended March 31, | |||||||||||||||
| 2018 | 2017 | 2018 | 2017 | |||||||||||||
| Weighted average shares outstanding | 35,162 | 31,453 | 35,304 | 34,769 | ||||||||||||
| Dilutive effect of stock options and restricted stock awards and units | - | 339 | - | 352 | ||||||||||||
| Diluted weighted average shares outstanding | 35,162 | 31,792 | 35,304 | 35,121 | ||||||||||||
The effect of approximately 100 and 181 common equivalent shares for the three and nine months ended March 31, 2018, respectively, was excluded from the diluted weighted average shares outstanding due to a net loss for the periods. There were 170 and 143 common equivalent shares outstanding for the three and nine months ended March 31, 2018, respectively, that were not included in the calculation of diluted net income per common share because their effect would have been anti-dilutive.
The weighted average shares outstanding for the three and nine months ended March 31, 2018 includes the effect of 5,122 shares to be issued beginning on December 21, 2019 in connection with the acquisition of certain products and related assets from Citron and Lucid (see Note 3).
The Convertible Senior Notes (see Note 7) will only be included in the dilutive net income per share calculations using the treasury stock method during periods in which the average market price of Aceto’s common stock is above the applicable conversion price of the Convertible Senior Notes, or $33.215 per share, and the impact would not be anti-dilutive.
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ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
(7) Debt
Long-term debt
| March 31, 2018 | June 30, 2017 | |||||||
| Convertible Senior Notes, net | $ | 126,279 | $ | 121,676 | ||||
| Revolving Bank Loans | 62,000 | 90,000 | ||||||
| Term Bank Loans | 128,526 | 139,227 | ||||||
| Mortgage | 2,615 | 2,763 | ||||||
| 319,420 | 353,666 | |||||||
| Less current portion | 190,723 | 14,466 | ||||||
| $ | 128,697 | $ | 339,200 | |||||
Convertible Senior Notes
In November 2015, Aceto offered $125,000 aggregate principal amount of Convertible Senior Notes due 2020 (the "Notes") in a private offering to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended. In addition, Aceto granted the initial purchasers for the offering an option to purchase up to an additional $18,750 aggregate principal amount pursuant to the initial purchasers’ option to purchase additional Notes, which was exercised in November 2015. Therefore, the total offering was $143,750 aggregate principal amount. The Notes are unsecured obligations of Aceto and rank senior in right of payment to any of Aceto’s subordinated indebtedness, equal in right of payment to all of Aceto’s unsecured indebtedness that is not subordinated, effectively junior in right of payment to any of Aceto’s secured indebtedness to the extent of the value of the assets securing such indebtedness and structurally junior in right of payment to all indebtedness and other liabilities (including trade payables) of Aceto’s subsidiaries. The Notes will be convertible into cash, shares of Aceto common stock or a combination thereof, at Aceto’s election, upon the satisfaction of specified conditions and during certain periods. The Notes will mature in November 2020. The Notes pay 2.0% interest semi-annually in arrears on May 1 and November 1 of each year, which commenced on May 1, 2016. The Notes are convertible into 4,328 shares of common stock, based on an initial conversion price of $33.215 per share.
Holders may convert all or any portion of their notes, in multiples of one thousand dollar principal amount, at their option at any time prior to the close of business on the business day immediately preceding May 1, 2020 only under the following circumstances: (i) during any calendar quarter (and only during such calendar quarter), if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day, (ii) during the five consecutive business day period after any five consecutive trading day period (which is referred to as the “measurement period”) in which the trading price per one thousand dollar principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of Aceto’s common stock and the conversion rate on each such trading day; or (iii) upon the occurrence of specified corporate events.
Upon conversion by the holders, the Company may elect to settle such conversion in shares of its common stock, cash, or a combination thereof. As a result of its cash conversion option, the Company separately accounted for the value of the embedded conversion option as a debt discount (with an offset to capital in excess of par value). The debt discount is being amortized as additional non-cash interest expense using the effective interest method over the term of the Notes. Debt issuance costs are being amortized as additional non-cash interest expense.The Company presents debt issuance costs as a direct deduction from the carrying value of the debt liability rather than showing the debt issuance costs as a deferred charge on the balance sheet.
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ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
In connection with the offering of the Notes, Aceto entered into privately negotiated convertible note hedge transactions with option counterparties, which are affiliates of certain of the initial purchasers. The convertible note hedge transactions are expected generally to reduce the potential dilution to Aceto’s common stock and/or offset any cash payments Aceto is required to make in excess of the principal amount of converted Notes upon any conversion of Notes. Aceto also entered into privately negotiated warrant transactions with the option counterparties. The warrant transactions could separately have a dilutive effect to the extent that the market price per share of Aceto’s common stock as measured over the applicable valuation period at the maturity of the warrants exceeds the applicable strike price of the warrants. By entering into these transactions with the option counterparties, the Company issued convertible debt and a freestanding “call-spread.”
The carrying value of the Notes is as follows:
March 31, 2018 | June 30, 2017 | |||||||
| Principal amount | $ | 143,750 | $ | 143,750 | ||||
| Unamortized debt discount | (15,278 | ) | (19,255 | ) | ||||
| Unamortized debt issuance costs | (2,193 | ) | (2,819 | ) | ||||
| Net carrying value | $ | 126,279 | $ | 121,676 | ||||
The following table sets forth the components of total “interest expense” related to the Notes recognized in the accompanying consolidated statements of operations for the three and nine months ended March 31:
| Nine Months Ended March 31, 2018 | Three Months Ended March 31, 2018 | |||||||
| Contractual coupon | $ | 2,127 | $ | 709 | ||||
| Amortization of debt discount | 3,977 | 1,347 | ||||||
| Amortization of debt issuance costs | 626 | 208 | ||||||
| $ | 6,730 | $ | 2,264 | |||||
Credit Facilities
On December 21, 2016 the Company entered into a Second Amended and Restated Credit Agreement (the “A&R Credit Agreement”), with eleven banks, which amended and restated in its entirety the Amended and Restated Credit Agreement, dated as of October 28, 2015, as amended by Amendment No. 1 to Amended and Restated Credit Agreement, dated as of November 10, 2015, and Amendment No. 2 to Amended and Restated Credit Agreement, dated as of August 26, 2016 (collectively, the “First Amended Credit Agreement”). The A&R Credit Agreement increased the aggregate available revolving commitment under the First Amended Credit Agreement from $150,000 to an initial aggregate available revolving commitment of $225,000 (the “Initial Revolving Commitment”). Under the A&R Credit Agreement, the Company may borrow, repay and reborrow from and as of December 21, 2016, to but excluding December 21, 2021 (the “Maturity Date”) provided, that if any of the Notes remain outstanding on the date that is 91 days prior to the maturity date of the Notes (the “2015 Convertible Maturity Date”), then the Maturity Date shall mean the date that is 91 days prior to the 2015 Convertible Maturity Date. The A&R Credit Agreement provides for (i) Eurodollar Loans (as such terms are defined in the A&R Credit Agreement), (ii) ABR Loans (as such terms are defined in the A&R Credit Agreement) or (iii) a combination thereof. As of March 31, 2018, the Company borrowed Revolving Loans (as defined under the A&R Credit Agreement) aggregating $62,000 which loans are Eurodollar Loans at interest rates ranging from 3.57% to 3.63% at March 31, 2018. The applicable interest rate margin percentage is subject to adjustment quarterly based upon the Company’s senior secured net leverage ratio.
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ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
Under the A&R Credit Agreement, the Company also borrowed $150,000 in term loans (the “Initial Term Loan). Subject to certain conditions, including obtaining commitments from existing or prospective lenders, the Company had the right to increase the amount of the Initial Revolving Commitment (each, a “Revolving Facility Increase” and, together with the Initial Revolving Commitment, the “Revolving Commitment”) and/or the Initial Term Loan in an aggregate amount not to exceed $100,000 pursuant to an incremental loan feature in the A&R Credit Agreement. As of March 31, 2018, the remaining amount outstanding under the Initial Term Loan was $131,250 and was payable as a Eurodollar Loan at an interest rate of 4.05%. The proceeds of the Initial Revolving Commitment and Initial Term Loan were used to partially finance the acquisition of generic products and related assets of Citron and its affiliate Lucid, and pay fees and expenses related thereto. The applicable interest rate margin percentage is subject to adjustment quarterly based upon the Company’s senior secured net leverage ratio.
The Initial Term Loan is payable as to principal in nineteen consecutive, equal quarterly installments of $3,750, which commenced on March 31, 2017 and will continue each March 31, June 30, September 30 and December 31 thereafter. To the extent not previously paid, the final payment on the Term Loan Maturity Date (as defined in the A&R Credit Agreement) shall be in an amount equal to the then outstanding unpaid principal amount of the Initial Term Loan.
The A&R Credit Agreement provides that commercial letters of credit shall be issued to provide the primary payment mechanism in connection with the purchase of any materials, goods or services in the ordinary course of business. The Company had no open letters of credit at March 31, 2018 and June 30, 2017.
In accordance with generally accepted accounting principles, deferred financing costs associated with the Initial Term Loan are presented as a direct deduction from the carrying value of the debt liability rather than showing the deferred financing costs as a deferred charge on the balance sheet. In addition, deferred financing costs associated with the Revolving Commitment have been recorded as a deferred charge on the balance sheet.
The A&R Credit Agreement provides for a security interest in substantially all the personal property of the Company and certain of its subsidiaries. The A&R Credit Agreement contains several financial covenants including, among other things, maintaining a minimum level of debt service and certain leverage ratios. Under the A&R Credit Agreement, the Company and its subsidiaries are also subject to certain restrictive covenants, including, among other things, covenants governing liens, limitations on indebtedness, limitations on guarantees, limitations on sales of assets and sales of receivables, and limitations on loans and investments.
On December 13, 2017, the Company entered into a First Amendment to the Second Amended and Restated Credit Agreement (the “2017 Amendment”), which amended the A&R Credit Agreement. The 2017 Amendment, among other things, contained several amendments to the financial covenants in the A&R Credit Agreement.
As of March 31, 2018, the Company was in compliance with all of its financial covenants except for the maximum total net leverage ratio and the minimum debt service coverage ratio. On May 3, 2018, the Company entered into a Second Amendment and Waiver to the Second Amended and Restated Credit Agreement (the “2018 Amendment”). The 2018 Amendment, among other things, contains a waiver of any event of default under the A&R Credit Agreement arising as a result of the non-compliance by the Company with the Total Net Leverage Ratio and Debt Service Coverage Ratio financial covenants, in each case, solely for the fiscal quarter ended March 31, 2018. The Amendment also contains several amendments to the A&R Credit Agreement including, among other things, (a) reducing the available revolving commitment thereunder to $100,000, and (b) during the period commencing on the closing of the 2018 Amendment and ending on the date the Company demonstrates compliance with each financial covenant set forth in the A&R Credit Agreement for the fiscal quarter ending June 30, 2018 (the “Limitation Period”; provided that if the Company is not in compliance with any of the financial covenants set forth in the A&R Credit Agreement for the fiscal quarter ending June 30, 2018, then the Limitation Period shall continue indefinitely): (i) fixing the applicable margin with respect to all loans under the A&R Credit Agreement to the highest level provided under the A&R Credit Agreement, which is 1.50% in the case of ABR Loans (as defined in the A&R Credit Agreement) and 2.50% in the case of Eurodollar Loans (as defined in the A&R Credit Agreement), (ii) fixing the commitment fee on the undrawn revolving commitments under the A&R Credit Agreement to the highest level provided under the A&R Credit Agreement which is 0.40% per annum, (iii) requiring the prior written consent of the Required Lenders (as defined in the A&R Credit Agreement) as a condition precedent to the lenders extending any Loans (as defined in the A&R Credit Agreement) or the issuing banks issuing, amending, renewing or extending any Letter of Credit (as defined in the A&R Credit Agreement), (iv) restricting the amount of dividends or distributions the Company may make to its shareholders to no more than $0.01 per share for the fiscal quarter ending on June 30, 2018 and, during the Limitation Period, restricting the Company from making any other dividends or distributions to its shareholders thereafter and (v) restricting the incurrence of certain indebtedness, limiting acquisitions and other investments and imposing certain other restrictions.
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ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
In accordance with GAAP, we have classified theindebtedness outstanding under the Company’s credit facility as a current liability as of March 31, 2018. This differs from the customary treatment heretofore applicable to indebtedness outstanding under the Company’s credit facility, in which only the portion of such indebtedness payable within one year from the balance sheet date has been recorded as a current liability. The waiver that the Company has received from its lenders under the credit facility applies solely to the non-compliance with certain financial covenants as of March 31, 2018 and thus does not waive non-compliance with any financial covenants as of June 30, 2018. It is probable that the Company will not comply with certain financial covenants as of June 30, 2018 in the absence of a material change in the Company’s operating results. That probability is the factor that has caused the Company to reclassify its indebtedness. The Company believes it will work cooperatively with its lenders over the next 120 days and anticipates that the financial covenants for the June 30, 2018 reporting date will be amended.
Mortgage
On June 30, 2011, the Company entered into a mortgage payable for $3,947 on its corporate headquarters, in Port Washington, New York. This mortgage payable is secured by the land and building and is being amortized over a period of 20 years. The mortgage payable, which was modified in October 2013, bears interest at 4.92% per annum as of March 31, 2018 and matures on June 30, 2021.
(8) Commitments, Contingencies and Other Matters
The Company and its subsidiaries are subject to various claims which have arisen in the normal course of business. The Company provides for costs related to contingencies when a loss from such claims is probable and the amount is reasonably determinable. In determining whether it is possible to provide an estimate of loss, or range of possible loss, the Company reviews and evaluates its litigation and regulatory matters on a quarterly basis in light of potentially relevant factual and legal developments. If the Company determines an unfavorable outcome is not probable or reasonably estimable, the Company does not accrue for a potential litigation loss. While the Company has determined that there is a reasonable possibility that a loss has been incurred, no amounts have been recognized in the financial statements, other than what has been discussed below, because the amount of the liability cannot be reasonably estimated at this time.
In fiscal years 2011, 2009, 2008 and 2007, the Company received letters from the Pulvair Site Group, a group of potentially responsible parties (PRP Group) who are working with the State of Tennessee (the State) to remediate a contaminated property in Tennessee called the Pulvair site. The PRP Group has alleged that Aceto shipped hazardous substances to the site which were released into the environment. The State had begun administrative proceedings against the members of the PRP Group and Aceto with respect to the cleanup of the Pulvair site and the PRP Group has begun to undertake cleanup. The PRP Group is seeking a settlement of approximately $1,700 from the Company for its share to remediate the site contamination. Although the Company acknowledges that it shipped materials to the site for formulation over twenty years ago, the Company believes that the evidence does not show that the hazardous materials sent by Aceto to the site have significantly contributed to the contamination of the environment and thus believes that, at most, it is a de minimis contributor to the site contamination. Accordingly, the Company believes that the settlement offer is unreasonable. Management believes that the ultimate outcome of this matter will not have a material adverse effect on the Company's financial condition or liquidity.
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ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
The Company has environmental remediation obligations in connection with Arsynco, Inc. (“Arsynco”), a subsidiary formerly involved in manufacturing chemicals located in Carlstadt, New Jersey, which was closed in 1993 and is currently held for sale. Based on continued monitoring of the contamination at the site and the approved plan of remediation, Arsynco received an estimate from an environmental consultant stating that the costs of remediation could be between $21,500 and $23,300. Remediation commenced in fiscal 2010, and as of March 31, 2018 and June 30, 2017, a liability of $4,495 and $8,451, respectively, is included in the accompanying consolidated balance sheets for this matter. For the nine months ended March 31, 2018, the Company recorded an environmental charge of $902, which is included in selling, general and administrative expenses in the accompanying condensed consolidated statement of operations for the nine months ended March 31, 2018. In accordance with GAAP, management believes that the majority of costs incurred to remediate the site will be capitalized in preparing the property which is currently classified as held for sale. An estimate of the fair value of the property has been determined by a third party real estate professional and supports the assumption that the expected fair value after the remediation is in excess of the amount required to be capitalized. However, these matters, if resolved in a manner different from those assumed in current estimates, could have a material adverse effect on the Company’s financial condition, operating results and cash flows when resolved in a future reporting period.
In connection with the environmental remediation obligation for Arsynco, in July 2009, Arsynco entered into a settlement agreement with BASF Corporation (“BASF”), the former owners of the Arsynco property. In accordance with the settlement agreement, BASF paid for a portion of the prior remediation costs and going forward, will co-remediate the property with the Company. The contract requires that BASF pay $550 related to past response costs and pay a proportionate share of the future remediation costs. Accordingly, the Company had recorded a gain of $550 in fiscal 2009. This $550 gain relates to the partial reimbursement of costs of approximately $1,200 that the Company had previously expensed. The Company also recorded an additional receivable from BASF, with an offset against property held for sale, representing its estimated portion of the future remediation costs. The balance of this receivable for future remediation costs as of March 31, 2018 and June 30, 2017 is $2,023 and $3,803, respectively, which is included in the accompanying consolidated balance sheets.
In March 2006, Arsynco received notice from the EPA of its status as a PRP under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) for a site described as the Berry’s Creek Study Area (“BCSA”). Arsynco is one of over 150 PRPs which have potential liability for the required investigation and remediation of the site. The estimate of the potential liability is not quantifiable for a number of reasons, including the difficulty in determining the extent of contamination and the length of time remediation may require. In addition, any estimate of liability must also consider the number of other PRPs and their financial strength. In July 2014, Arsynco received notice from the U.S. Department of Interior (“USDOI”) regarding the USDOI’s intent to perform a Natural Resource Damage (NRD) Assessment at the BCSA. Arsynco has to date declined to participate in the development and performance of the NRD assessment process. Based on prior practice in similar situations, it is possible that the State may assert a claim for natural resource damages with respect to the Arsynco site itself, and either the federal government or the State (or both) may assert claims against Arsynco for natural resource damages in connection with Berry's Creek; any such claim with respect to Berry's Creek could also be asserted against the approximately 150 PRPs which the EPA has identified in connection with that site. Any claim for natural resource damages with respect to the Arsynco site itself may also be asserted against BASF, the former owners of the Arsynco property. In September 2012, Arsynco entered into an agreement with three of the other PRPs that had previously been impleaded into New Jersey Department of Environmental Protection, et al. v. Occidental Chemical Corporation, et al., Docket No. ESX-L-9868-05 (the "NJDEP Litigation") and were considering impleading Arsynco into the same proceeding. Arsynco entered into an agreement to avoid impleader. Pursuant to the agreement, Arsynco agreed to (1) a tolling period that would not be included when computing the running of any statute of limitations that might provide a defense to the NJDEP Litigation; (2) the waiver of certain issue preclusion defenses in the NJDEP Litigation; and (3) arbitration of certain potential future liability allocation claims if the other parties to the agreement are barred by a court of competent jurisdiction from proceeding against Arsynco. In July 2015, Arsynco was contacted by an allocation consultant retained by a group of the named PRPs, inviting Arsynco to participate in the allocation among the PRPs’ investigation and remediation costs relating to the BCSA. Arsynco declined that invitation. Since an amount of the liability cannot be reasonably estimated at this time, no accrual is recorded for these potential future costs. The impact of the resolution of this matter on the Company’s results of operations in a particular reporting period is not currently known.
A subsidiary of the Company markets certain agricultural protection products which are subject to the Federal Insecticide, Fungicide and Rodenticide Act (FIFRA). FIFRA requires that test data be provided to the EPA to register, obtain and maintain approved labels for pesticide products. The EPA requires that follow-on registrants of these products compensate the initial registrant for the cost of producing the necessary test data on a basis prescribed in the FIFRA regulations. Follow-on registrants do not themselves generate or contract for the data. However, when FIFRA requirements mandate that new test data be generated to enable all registrants to continue marketing a pesticide product, often both the initial and follow-on registrants establish a task force to jointly undertake the testing effort. The Company is presently a member of several such task force groups, which requires payments for such memberships. In addition, in connection with our agricultural protection business, the Company plans to acquire product registrations and related data filed with the United States Environmental Protection Agency to support such registrations and other supporting data for several products. The acquisition of these product registrations and related data filed with the United States Environmental Protection Agency as well as payments to various task force groups could approximate $2,299 through the remainder of fiscal 2018.
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ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
The Company has been notified by the U.S. government that 11 generic drug products it acquired through its Acetris Health subsidiary in a product purchase agreement with Lucid are not in compliance with the federal Trade Agreement Act (“TAA”) country-of-origin provisions of a clause contained in the government supply contracts acquired from Lucid (the “TAA Notification”). The 11 finished dosage form products purchased by the U.S. government are manufactured by Aurolife Pharma LLC which is located in Dayton, New Jersey using APIs sourced from India. In conjunction with this finding, the U.S. Department of Veterans Affairs (“VA”) requested that Aceto supply new TAA-compliant sources for the referenced products by March 9, 2018 and supply new TAA-compliant drugs to the government purchasers under the contracts by March 26, 2018. The Company was not able to meet these deadlines and thereafter Acetris and the government entered into agreements that provided for a no-cost termination of each of the 11 supply contracts.
Under current longstanding law, the government, under the Buy America Act, is permitted to buy domestic end products, including commercial off-the-shelf (“COTS”) products like generic drugs that are manufactured in the U.S. even if their components are not all manufactured in the US. The Company believes that the government was and is permitted to buy Acetris’ products, because they are COTS items manufactured in the U.S. As a result, the Company has disputed the determination that the 11 products sold pursuant to novated contracts with the VA originate in India rather than the United States and has appealed the decision that it is not currently compliant with contract sourcing requirements. To further pursue remedies, Aceto has asserted an indemnification claim against the sellers under the product purchase agreement dated December 21, 2016. In addition, the U.S. Defense Logistics Agency, by letter dated April 25, 2018 to Acetris, requested that Acetris seek a ruling from U.S. Customs and Border Protection that seven products specified therein, each of which have APIs sourced from India, are TAA compliant.
In March 2018, Sigmapharm Laboratories, LLC (“SigmaPharm”) commenced an action against Rising and the Company in the United States District Court for the Eastern District of Pennsylvania. The complaint arises out of an agreement, effective as of June 22, 2006 (the “SigmaPharm Agreement”), pursuant to which SigmaPharm agreed to supply certain generic pharmaceutical products (the “Products”) to Rising, and Rising in turn agreed to market and distribute the Products in the United States and pay SigmaPharm a share of the profits pursuant to a formula specified in the Agreement. The complaint alleges that Rising and Aceto breached the Agreement by failing to pay or timely make payments due under the Agreement and to disclose certain information to SigmaPharm. The complaint seeks, among other relief, a declaration that the Agreement has been terminated and that SigmaPharm has exclusive marketing and distribution rights to the Products; injunctive relief; and an unspecified amount of damages. The Company intends to vigorously defend the action and assert counterclaims against SigmaPharm in the course of this litigation.
(9) Fair Value Measurements
GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly fashion between market participants at the measurement date. GAAP establishes a fair value hierarchy for those instruments measured at fair value that distinguishes between assumptions based on market data (observable inputs) and the Company’s assumptions (unobservable inputs). The hierarchy consists of three levels:
Level 1 – Quoted market prices in active markets for identical assets or liabilities;
Level 2 – Inputs other than Level 1 inputs that are either directly or indirectly observable; and
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ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
Level 3 – Unobservable inputs that are not corroborated by market data.
On a recurring basis, Aceto measures at fair value certain financial assets and liabilities, which consist of cash equivalents, investments and foreign currency contracts. The Company classifies cash equivalents and investments within Level 1 if quoted prices are available in active markets. Level 1 assets include instruments valued based on quoted market prices in active markets which generally include corporate equity securities publicly traded on major exchanges. Time deposits are very short-term in nature and are accordingly valued at cost plus accrued interest, which approximates fair value, and are classified within Level 2 of the valuation hierarchy. The Company uses foreign currency futures contracts to minimize the risk caused by foreign currency fluctuation on its foreign currency receivables and payables by purchasing futures with one of its financial institutions. Futures are traded on regulated U.S. and international exchanges and represent commitments to purchase or sell a foreign currency at a future date and at a specific price. Aceto’s foreign currency derivative contracts are classified within Level 2 as the fair value of these hedges is primarily based on observable futures foreign exchange rates. At March 31, 2018, the Company had foreign currency contracts outstanding that had a notional amount of $62,350. Unrealized (losses) gains on hedging activities for the three and nine months ended March 31, 2018 was ($34) and $227, respectively. Unrealized gains (losses) on hedging activities for the three and nine months ended March 31, 2017 was $353 and ($230), respectively, and are included in interest and other income, net, in the consolidated statements of operations. The contracts have varying maturities of less than one year.
In conjunction with its existing credit agreement (see Note 7), the Company entered an interest rate swap on March 21, 2017 for an additional interest cost of 2.005% on a notional amount of $100,000, which has been designated as a cash flow hedge. The expiration date of this interest rate swap is December 21, 2021. The remaining notional balance of this derivative as of March 31, 2018 is $87,500. The unrealized gain to date associated with this derivative, which is recorded in accumulated other comprehensive income in the consolidated balance sheet at March 31, 2018, is $1,539. Aceto’s interest rate swaps are classified within Level 2 as the fair value of this hedge is primarily based on observable interest rates.
At March 31, 2018, the Company had accrued $752 of contingent consideration, $663 of which related to the acquisition of certain products and related assets of Citron and Lucid, which was completed in December 2016 (see Note 3) and $89 of contingent consideration related to a previously acquired company in France. At June 30, 2017, the Company had accrued $2,952 of contingent consideration, $2,807 of which related to the acquisition of certain products and related assets of Citron and Lucid and $145 of contingent consideration related to a previously acquired company in France. The contingent consideration was calculated using the present value of a probability weighted income approach.
The Company accounts for goodwill and intangible assets in accordance with ASC 350, Intangibles – Goodwill and Other (“ASC 350”). ASC 350 requires that goodwill and other intangibles with indefinite lives be tested for impairment annually or on an interim basis if events or circumstances indicate that the fair value of an asset has decreased below its carrying value. During the third quarter of fiscal 2018,the Company’s Rising Pharmaceuticals reporting unit (which is part of the Human Health segment) had a decline in actual and forecasted revenue and earnings due to the persistent adverse conditions in the generics market. In addition, as noted above, the Company was notified by the U.S. government that 11 generic drug products it acquired through its Acetris Health subsidiary (part of the Rising reporting unit which is part of the Human Health segment) in a product purchase agreement with an entity formerly known as Lucid Pharma LLC are not in compliance with the federal Trade Agreement Act country-of-origin provisions of a clause contained in the government supply contracts acquired from Lucid. Based on these indicators, the Company determined that it was necessary to perform an interim goodwill impairment analysis at March 31, 2018 for its Rising reporting unit. The Company elected to early adopt Accounting Standards Update (“ASU”) 2017-04,Intangibles- Goodwill and Other (Topic 350),during the third quarter of fiscal 2018 which eliminated the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, the amount of an impairment charge is recognized if the carrying amount of a reporting unit is greater than its fair value.The fair value of the Rising reporting unit was estimated using many assumptions and estimates and a market participant approach that directly impacts the results of the testing. In making these assumptions and estimates, the Company used industry accepted valuation models and set criteria that were reviewed and approved by various levels of management. Accordingly, with respect to the third quarter of fiscal 2018, the Company recognized a pre-tax non-cash goodwill impairment charge of $235,110 related to the Rising reporting unit.
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ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
Long-lived assets and certain identifiable intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If it is determined such indicators are present and the review indicates that the assets will not be fully recoverable, based on undiscounted estimated cash flows over the remaining amortization periods, their carrying values are reduced to estimated fair value. Measurements based on undiscounted cash flows are Level 3 inputs. As noted above, during the third quarter of fiscal 2018,the Company’s Rising Pharmaceuticals subsidiary had a decline in actual and forecasted revenue and earnings and therefore the Company performed an impairment test on the related intangibles. The projected undiscounted cash flows for certain intangibles were determined to be less than the carrying value, and as a result, the Company recognized an impairment charge of $5,745 in the third quarter of fiscal 2018. Additionally, as noted above, the Company was notified by the U.S. government that 11 generic drug products it acquired through its Acetris Health subsidiary in a product purchase agreement with an entity formerly known as Lucid Pharma LLC are not in compliance with the federal Trade Agreement Act country-of-origin provisions of a clause contained in the government supply contracts acquired from Lucid. Based on this, the Company performed an impairment test on the related intangible asset and recognized an impairment charge of $15,411 on the customer relationships intangible asset in the third quarter of fiscal 2018.
The total impairment charges for goodwill and intangibles recorded in the third quarter of fiscal 2018 was $256,266, all of which related to the Rising reporting unit which is part of the Human Health segment.
In connection with the acquisition of certain products and related assets of Citron and Lucid (see Note 3), the Company will issue 5,122 shares of Aceto common stock beginning on December 21, 2019. The preliminary fair value of the future issuance of these shares was determined to be $90,400 at the time of the product acquisition after taking into effect that the shares won’t be issued until the third and fourth anniversary of the closing and the present value calculation of dividends.
In November 2015, the Company issued $143,750 aggregate principal amount of Notes (see Note 7). Since Aceto has the option to settle the potential conversion of the Notes in cash, the Company separated the embedded conversion option feature from the debt feature and accounts for each component separately, based on the fair value of the debt component assuming no conversion option. The calculation of the fair value of the debt component required the use of Level 3 inputs, and was determined by calculating the fair value of similar non-convertible debt, using a theoretical borrowing rate of 6.5%.The value of the embedded conversion option was determined using an expected present value technique (income approach) to estimate the fair value of similar non-convertible debt and included utilization of convertible investors’ credit assumptions and high yield bond indices. The Notes approximate a full fair value of $126,600 at March 31, 2018 giving effect to certain factors, including the term of the Notes, current stock price of Aceto stock and effective interest rate.
The carrying values of all financial instruments classified as a current asset or current liability are deemed to approximate fair value because of the short maturity of these instruments. The fair values of the Company’s notes receivable and short-term and long-term bank loans were based upon current rates offered for similar financial instruments to the Company.
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ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
The following tables summarize the valuation of the Company’s financial assets and liabilities which were determined by using the following inputs at March 31, 2018 and June 30, 2017:
| Fair Value Measurements at March 31, 2018 Using | ||||||||||||||||
| Quoted Prices in Active Markets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total | |||||||||||||
| Cash equivalents: | ||||||||||||||||
| Time deposits | - | $ | 2,746 | - | $ | 2,746 | ||||||||||
| Investments: | ||||||||||||||||
| Time deposits | - | 3,059 | - | 3,059 | ||||||||||||
| Foreign currency contracts-assets(1) | - | 285 | - | 285 | ||||||||||||
| Foreign currency contracts-liabilities(2) | - | 318 | - | 318 | ||||||||||||
| Derivative asset for interest rate swap(3) | - | 1,539 | - | 1,539 | ||||||||||||
| Contingent consideration(4) | - | - | $ | 752 | 752 | |||||||||||
| (1) | Included in “Other receivables” in the accompanying Condensed Consolidated Balance Sheet as of March 31, 2018. |
| (2) | Included in “Accrued expenses” in the accompanying Condensed Consolidated Balance Sheet as of March 31, 2018. |
| (3) | Included in “Other assets” in the accompanying Condensed Consolidated Balance Sheet as of March 31, 2018. |
| (4) | $89 included in “Accrued expenses” and $663 included in “Long-term liabilities” in the accompanying Condensed Consolidated Balance Sheet as of March 31, 2018. |
| Fair Value Measurements at June 30, 2017 Using | ||||||||||||||||
| Quoted Prices in Active Markets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total | |||||||||||||
| Cash equivalents: | ||||||||||||||||
| Time deposits | - | $ | 5,781 | - | $ | 5,781 | ||||||||||
| Investments: | ||||||||||||||||
| Time deposits | - | 2,046 | - | 2,046 | ||||||||||||
| Foreign currency contracts-assets (5) | - | 486 | - | 486 | ||||||||||||
| Foreign currency contracts-liabilities (6) | - | 137 | - | 137 | ||||||||||||
| Derivative liability for interest rate swap (7) | - | 581 | - | 581 | ||||||||||||
| Contingent consideration (8) | - | - | $ | 2,952 | 2,952 | |||||||||||
| (5) | Included in “Other receivables” in the accompanying Condensed Consolidated Balance Sheet as of June 30, 2017. |
| (6) | Included in “Accrued expenses” in the accompanying Condensed Consolidated Balance Sheet as of June 30, 2017. |
| (7) | Included in “Long-term liabilities” in the accompanying Condensed Consolidated Balance Sheet as of June 30, 2017. |
| (8) | $145 included in “Accrued expenses” and $2,807 included in “Long-term liabilities” in the accompanying Condensed Consolidated Balance Sheet as of June 30, 2017. |
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ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
(10) Recent Accounting Pronouncements
In February 2018, the Financial Accounting Standards Board (“FASB”) issued ASU 2018-02,Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,which gives entities the option to reclassify the disproportionate income tax effects ("stranded tax effects") caused by the newly-enacted U.S. Tax Cuts and Jobs Act from accumulated other comprehensive income to retained earnings. The update also requires new disclosures, some of which are applicable for all entities. The guidance in ASU 2018-02 is effective for annual reporting periods beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the impact of the provisions of ASU 2018-02.
In August 2017, the FASB issued ASU 2017-12,Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which has the objective of improving the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. In addition to that main objective, the amendments in ASU 2017-12 make certain targeted improvements to simplify the application of the hedge accounting guidance in current GAAP. The amendments in ASU 2017-12 are effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact of the provisions of ASU 2017-12.
In May 2017, the FASB issued ASU 2017-09,Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting, which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. ASU 2017-09 is effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted. The Company does not believe this new accounting standard update will have a material impact on its consolidated financial statements.
In January 2017, the FASB issued ASU 2017-01Business Combinations (Topic 805): Clarifying the Definition of a Business,with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 is effective for public companies for annual periods beginning after December 15, 2017, including interim periods within those periods. The Company does not believe this new accounting pronouncement will have a material impact on its consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15,Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which addresses eight specific cash flow issues with the objective of reducing diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company is currently evaluating the impact of the provisions of ASU 2016-15.
In March 2016, the FASB issued ASU 2016-09,Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which changes certain aspects of accounting for share-based payments to employees. The Company adopted ASU 2016-09 as of July 1, 2017. ASU 2016-09 requires that all tax benefits and deficiencies related to share-based payments be recognized and recorded through the statement of income for all awards settled or expiring after the adoption of ASU 2016-09. Under prior guidance, tax benefits in excess of compensation costs ("windfalls") were recorded in equity, and any tax deficiencies ("shortfalls") were recorded in equity to the extent of previous windfalls and then to the statement of income. For the three months and nine months ended March 31, 2018, the Company recorded additional tax expense of $420 and $1,521, respectively, associated with net tax deficiencies. ASU 2016-09 also requires, either prospectively or retrospectively, that all tax-related cash flows resulting from share-based payments be reported as operating activities on the statement of cash flows, a change from prior guidance that required windfall tax benefits to be presented as an inflow from financing activities and an outflow from operating activities on the statement of cash flows. The Company has elected to adopt such presentation on a prospective basis. Additionally, ASU 2016-09 allows entities to make an accounting policy election for the impact of most types of forfeitures on the recognition of expense for share-based payment awards by allowing the forfeitures to be either estimated, as was required under prior guidance, or recognized when they actually occur. Under ASU 2016-09, the Company recognizes forfeitures when they occur.
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ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
In February 2016, the FASB issued ASU 2016-02,Leases (Topic 842) that replaces existing lease guidance. The new standard is intended to provide enhanced transparency and comparability by requiring lessees to record right-of-use assets and corresponding lease liabilities on the balance sheet. The new guidance will continue to classify leases as either finance or operating, with classification affecting the pattern of expense recognition in the statement of income. ASU 2016-02 is effective for fiscal years (and interim reporting periods within those years) beginning after December 15, 2018. The Company is currently evaluating the impact of the provisions of ASU 2016-02.
In November 2015, the FASB issued ASU 2015-17,Income Taxes (Topic 740): Balance Sheet Classification of Deferred Assets.This ASU is intended to simplify the presentation of deferred taxes on the balance sheet and requires an entity to present all deferred tax assets and deferred tax liabilities as non-current on the balance sheet. Under the prior guidance, entities were required to separately present deferred taxes as current or non-current. Netting deferred tax assets and deferred tax liabilities by tax jurisdiction will still be required under the new guidance. The Company prospectively adopted the provisions of ASU 2015-17, as of July 1, 2017. The Company's prospective adoption of ASU 2015-17 impacts the classification of deferred tax assets and liabilities on any balance sheet that reports the Company's financial position for any date after June 30, 2017. Balance sheets for prior periods have not been adjusted. The adoption of ASU 2015-17 has no impact on the Company's results of operations or cash flows.
In July 2015, the FASB issued ASU 2015-11,Inventory (Topic 330):Simplifying the Measurement of Inventory. This ASU requires that an entity measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. This guidance is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company adopted this standard in the first quarter of fiscal year 2018. The adoption of this standard did not have any impact on the condensed consolidated financial statements of the Company.
In May 2014, the FASB issued ASU 2014-09,Revenue from Contracts with Customers (Topic 606), which is the new comprehensive revenue recognition standard that will supersede all existing revenue recognition guidance under U.S. GAAP. The standard's core principle is that a company will recognize revenue when it transfers promised goods or services to a customer in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In August 2015, the FASB subsequently issued ASU 2015-14,Revenue from Contracts with Customers - Deferral of the Effective Date, which approved a one-year deferral of ASU 2014-09 for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. In March 2016 and April 2016, the FASB issued ASU 2016-08,Revenue from Contracts with Customers - Principal versus Agent Considerations (Reporting Revenue Gross versus Net), and ASU 2016-10,Revenue from Contracts with Customers - Identifying Performance Obligations and Licensing, respectively, which further clarify the guidance related to those specific topics within ASU 2014-09. In May 2016, the FASB issued ASU 2016-12,Revenue from Contracts with Customers - Narrow Scope Improvements and Practical Expedients, to reduce the risk of diversity in practice for certain aspects in ASU 2014-09, including collectibility, noncash consideration, presentation of sales tax and transition. Additionally, in December 2016, the FASB issued ASU 2016-20,Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. ASU 2016-20 makes minor corrections or minor improvements to the standard that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. The Company has made progress in its evaluation of the amended guidance, including identification of revenue streams. The Company recognizes revenue from product sales at the time of shipment and passage of title and risk of loss and control of the goods is transferred to the customer. The Company has no acceptance or other post-shipment obligations and does not offer product warranties or services to its customers. Although the Company is continuing to assess the impact of the amended guidance, Aceto generally anticipates that the timing of recognition of revenue will be substantially unchanged under the amended guidance. The amended guidance will be effective for Aceto in the first quarter of fiscal 2019 and permits adoption under either the full retrospective approach (recognize effects of the amended guidance in each prior reporting period presented) or the modified retrospective approach (recognize the cumulative effect of adoption as an adjustment to retained earnings at the date of initial application). The Company anticipates adopting this amended standard on a modified retrospective basis.
| 26 |
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
(11) Segment Information
The Company's business is organized along product lines into three principal segments: Human Health, Pharmaceutical Ingredients and Performance Chemicals.
Human Health - includes finished dosage form generic drugs and nutraceutical products.
Pharmaceutical Ingredients –includes pharmaceutical intermediates and active pharmaceutical ingredients (“APIs”).
Performance Chemicals- The Performance Chemicals segment is made up of two product groups: Specialty Chemicals and Agricultural Protection Products. Specialty Chemicals include a variety of chemicals used in the manufacture of plastics, surface coatings, cosmetics and personal care, textiles, fuels and lubricants, perform to their designed capabilities. Dye and pigment intermediates are used in the color-producing industries such as textiles, inks, paper, and coatings. Organic intermediates are used in the production of agrochemicals.
Agricultural Protection Products include herbicides, fungicides and insecticides that control weed growth as well as control the spread of insects and other microorganisms that can severely damage plant growth.
The Company's chief operating decision maker evaluates performance of the segments based on net sales, gross profit and income before income taxes. Unallocated corporate amounts are deemed by the Company as administrative, oversight costs, not managed by the segment managers. The Company does not allocate assets by segment because the chief operating decision maker does not review the assets by segment to assess the segments' performance, as the assets are managed on an entity-wide basis. During all periods presented, our chief operating decision maker has been the Chief Executive Officer of the Company. In accordance with GAAP, the Company has aggregated certain operating segments into reportable segments because they have similar economic characteristics, and the operating segments are similar in all of the following areas: (a) the nature of the products and services; (b) the nature of the production processes; (c) the type or class of customer for their products and services; (d) the methods used to distribute their products or provide their services; and (e) the nature of the regulatory environment.
Nine months Ended March 31, 2018 and 2017:
| Human Health | Pharmaceutical Ingredients | Performance Chemicals | Unallocated Corporate | Consolidated Totals | ||||||||||||||||
| 2018 | ||||||||||||||||||||
| Net sales | $ | 301,407 | $ | 113,406 | $ | 127,669 | $ | - | $ | 542,482 | ||||||||||
| Gross profit | 57,080 | 17,259 | 27,310 | - | 101,649 | |||||||||||||||
| (Loss) income before income taxes | (258,172 | )* | 5,795 | 14,121 | (23,142 | ) | (261,398 | ) | ||||||||||||
| 2017 | ||||||||||||||||||||
| Net sales | $ | 201,686 | $ | 121,253 | $ | 120,759 | $ | - | $ | 443,698 | ||||||||||
| Gross profit | 56,424 | 19,867 | 27,672 | - | 103,963 | |||||||||||||||
| Income (loss) before income taxes | 13,912 | 7,299 | 13,599 | (20,452 | ) | 14,358 | ||||||||||||||
* Includes goodwill impairment charge of $235,110. See Note 9 Fair Value Measurements for details.
| 27 |
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
Three months Ended March 31, 2018 and 2017:
| Human Health | Pharmaceutical Ingredients | Performance Chemicals | Unallocated Corporate | Consolidated Totals | ||||||||||||||||
| 2018 | ||||||||||||||||||||
| Net sales | $ | 91,926 | $ | 43,201 | $ | 50,871 | $ | - | $ | 185,998 | ||||||||||
| Gross profit | 9,535 | 7,038 | 11,123 | - | 27,696 | |||||||||||||||
| (Loss) income before income taxes | (265,486 | )* | 2,987 | 6,699 | (7,237 | ) | (263,037 | ) | ||||||||||||
| 2017 | ||||||||||||||||||||
| Net sales | $ | 99,816 | $ | 43,821 | $ | 46,491 | $ | - | $ | 190,128 | ||||||||||
| Gross profit | 25,300 | 7,255 | 9,764 | - | 42,319 | |||||||||||||||
| Income (loss) before income taxes | 5,007 | 3,036 | 5,034 | (4,565 | ) | 8,512 | ||||||||||||||
* Includes goodwill impairment charge of $235,110. See Note 9 Fair Value Measurements for details.
(12) Income Taxes
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“the TCJA”) was signed by the U.S. President, which enacted various changes to the U.S. corporate tax law. Some of the most significant provisions impacting corporations include a reduced U.S. corporate income tax rate from 35% to 21% effective in 2018, a one-time "deemed repatriation" tax on unremitted earnings accumulated in non-U.S. jurisdictions, limitation on deductibility of interest, the transition of U.S. international taxation from a worldwide tax system to a territorial tax system and other provisions. U.S. GAAP accounting for income taxes requires that Aceto record the impacts of any tax law change on the Company’s deferred income taxes in the quarter that the tax law change is enacted. Due to the complexities involved in accounting for the enactment of the TCJA, SEC Staff Accounting Bulletin (“SAB”) 118 allows Aceto to provide a provisional estimate of the impacts of the TCJA in its earnings for the fiscal year ended June 30, 2018. Accordingly, based on currently available information, the Company recorded additional income tax expense of $12,720 for the nine months ended March 31, 2018. This charge is comprised of $3,342 related to the remeasurement of Aceto’s deferred tax assets arising from a lower U.S. corporate tax rate, $7,012 related to the deemed repatriation of unremitted earnings of foreign subsidiaries and $2,366 related to deferred tax liabilities for local tax authorities as the Company no longer asserts permanent reinvestment of its undistributed non-U.S. subsidiaries' earnings. Additional impacts from the enactment of the TCJA will be recorded as they are identified during the measurement period ending no later than December 22, 2018 as provided for in SAB 118. The charge recorded in the nine months ended March 31, 2018 represents the Company’s best estimate of the impact of the TCJA. The Company will continue to evaluate the interpretations and assumptions made, guidance that may be issued and actions the Company may take as a result of the TCJA, which could materially change this estimate in 2018 as new information becomes available.
Deferred tax assets are recorded for net operating losses and temporary differences between the book and tax basis of assets and liabilities expected to produce tax deductions in future periods. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the tax periods in which those deferred tax assets would be deductible. A valuation allowance is taken when necessary to reduce deferred tax assets to the amount expected to be realized. When determining the amount of net deferred tax assets that are more likely than not to be realized, the Company assesses all available positive and negative evidence. This evidence includes, but is not limited to, scheduled reversal of deferred tax liabilities, prior earnings history, projected future earnings, carry-back and carry-forward periods and the feasibility of ongoing tax strategies that could potentially enhance the likelihood of the realization of a deferred tax asset. The weight given to the positive and negative evidence is commensurate with the extent the evidence may be objectively verified. As such, it is generally difficult for positive evidence regarding projected future taxable income (exclusive of reversing taxable temporary differences and carryforwards) to outweigh objective negative evidence such as the Company’s recent financial reporting loss for the three and nine months ended March 31, 2018 that created a cumulative loss. Therefore, the Company recorded a valuation allowance of $71,350 against its net U.S. deferred tax assets during the three and nine months ended March 31, 2018.
| 28 |
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
(13) Subsequent Events
On April 18, 2018, the Company issued a press release announcing, among other things, that (i) it was negotiating with its bank lenders a waiver of its credit agreement with respect to its total net leverage and debt service coverage financial covenants in the fiscal third quarter, (ii) the financial guidance issued on February 1, 2018 should no longer be relied upon, (iii) the Companyanticipated recording substantial non-cash intangible asset impairment charges as described herein and (iv) the resignation of Edward Borkowski as its chief financial officer. Subsequently, the market price of the Company’s common stock declined significantly and several law firms publicly announced that they were investigating alleged violations of law associated with the matters described in the Company’s press release. Thereafter, Aceto and certain related individuals have been named as defendants in civil lawsuitsthat allege, among other things, that Aceto made false and misleading statements to investors in public filings that preceded the April 18, 2018 press release. The Company is currently preparing its responses to these legal proceedings.
In connection with the Department of Justice’s ongoing investigation into marketing and pricing practices throughout the generic pharmaceutical industry, the Company has received a subpoena from the Antitrust Division of the U.S. Department of Justice (the “DOJ”). The Company is one of many operating companies in the generic pharmaceutical industry to receive a subpoena from the DOJ relating to its years-long investigation into the industry. The Company is currently preparing its response to the subpoena.
| 29 |
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Aceto Corporation
Port Washington, NY
Results of Review of Interim Consolidated Financial Statements
We have reviewed the condensed consolidated balance sheet of Aceto Corporation and subsidiaries as of March 31, 2018 and related condensed consolidated statements of operations and comprehensive income (loss) for the three-month and nine-month periods ended March 31, 2018 and 2017, and cash flows for the nine-month periods ended March 31, 2018 and 2017 included in the accompanying Securities and Exchange Commission Form 10-Q for the period ended March 31, 2018. Based on our reviews, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board, the consolidated balance sheet of Aceto Corporation and subsidiaries as of June 30, 2017, and the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for the year then ended (not presented herein); and in our report dated August 25, 2017, except for Note 2 which is dated November 9, 2017, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of June 30, 2017, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
Basis for Review Results
These interim financial statements are the responsibility of the Company’s management. We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
Emphasis of Matter
As discussed in Note 2 to the condensed consolidated financial statements, the March 31, 2018 consolidated financial statements have been restated to correct a misstatement.
/s/ BDO USA, LLP
Melville, New York
May 4, 2018, except for Notes 2 and 12 which are October 12, 2018
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY STATEMENT RELATING TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Quarterly Report contains forward-looking statements as that term is defined in the federal securities laws. The events described in forward-looking statements contained in this Quarterly Report may not occur. Generally, these statements relate to our business plans or strategies, projected or anticipated benefits or other consequences of our plans or strategies, financing plans, projected or anticipated benefits from acquisitions that we may make, or projections involving anticipated revenues, earnings or other aspects of our operating results or financial position, and the outcome of any contingencies. Any such forward-looking statements are based on current expectations, estimates and projections of management. We intend for these forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements. Words such as “may,” “will,” “expect,” “believe,” “anticipate,” “project,” “plan,” “intend,” “estimate,” and “continue,” and their opposites and similar expressions are intended to identify forward-looking statements. We caution you that these statements are not guarantees of future performance or events and are subject to a number of uncertainties, risks and other influences, many of which are beyond our control that may influence the accuracy of the statements and the projections upon which the statements are based. Factors that could cause actual results to differ materially from those set forth or implied by any forward-looking statement include, but are not limited to, our ability to remain competitive with competitors, risks associated with the generic product industry, dependence on a limited number of suppliers, risks associated with healthcare reform and reductions in reimbursement rates, difficulty in predicting revenue stream and gross profit, industry and market changes, the effect of fluctuations in operating results on the trading price of our common stock, risks associated with holding a significant amount of debt, inventory levels, reliance on outside manufacturers, risks of incurring uninsured environmental and other industry specific liabilities, governmental approvals and regulations, risks associated with hazardous materials, potential violations of government regulations, product liability claims, reliance on Chinese suppliers, potential changes to Chinese laws and regulations, potential changes to laws governing our relationships in India, fluctuations in foreign currency exchange rates, tax assessments, changes in tax rules, global economic risks, risk of unsuccessful acquisitions, effect of acquisitions on earnings, indemnification liabilities, terrorist activities, reliance on key executives, litigation risks, volatility of the market price of our common stock, changes to estimates, judgments and assumptions used in preparing financial statements, failure to maintain effective internal controls, and compliance with changing regulations, as well as other risks and uncertainties discussed in our reports filed with the Securities and Exchange Commission, including, but not limited to this Quarterly Report on Form 10-Q, the Company’s Annual Report on Form 10-K for the year ended June 30, 2017, as amended (the “2017 10-K”) and other filings. Copies of these filings are available at www.sec.gov.
Any one or more of these uncertainties, risks and other influences could materially affect our results of operations and whether forward-looking statements made by us ultimately prove to be accurate. Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether from new information, future events or otherwise.
NOTE REGARDING DOLLAR AMOUNTS
In this quarterly report, all dollar amounts are expressed in thousands, except for per-share amounts.
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to provide the readers of our financial statements with a narrative discussion about our business. The MD&A is provided as a supplement to and should be read in conjunction with our financial statements and the accompanying notes.
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Executive Summary
We are reporting net sales of $542,482 for the nine months ended March 31, 2018, which represents a 22.3% increase from the $443,698 reported in the comparable prior period. Gross profit for the nine months ended March 31, 2018 was $101,649 and our gross margin was 18.7% as compared to gross profit of $103,963 and gross margin of 23.4% in the comparable prior period. Our selling, general and administrative costs (“SG&A”) for the nine months ended March 31, 2018 was $87,241, an increase of $11,627 from what we reported in the prior period. On April 18, 2018, the Company issued a press release announcing that we intended to record substantial impairment charges, including goodwill, due to the persistent adverse conditions in the generics market. As set forth in Note 9 to the Company’s Condensed Consolidated Financial Statements, we recorded impairment charges of $256,266 during the three months ended March 31, 2018. In addition, as disclosed in Notes 2 and 12, we recorded a valuation allowance of $71,350 against our U.S. net deferred tax assets during the three and nine months ended March 31, 2018. We had a net loss of $281,395 or $8.00 per diluted share, for the nine months ended March 31, 2018, compared to net income of $9,409, or $0.30 per diluted share, in the prior period.
The Company is incurring substantial expenses to address the issues that led to the impairment charges taken as of March 31, 2018. As announced by the Company in its April 18, 2019 press release, the Company will pay a flat monthly fee of $250 for the services of its interim chief financial officer,Rebecca Roof. The Company has also retained financial and legal advisors to assist it in dealing with the various challenges that the Company is currently facing.
Included in the Company’s press release issued April 18, 2018, is the announcement that the Board of Directors has initiated a process to identify and evaluate a range of strategic alternatives. Strategic alternatives to be considered may include the sale of a key business segment(s), a merger or other business combination with another party, continuing as a standalone entity or other potential alternatives. The Company has retained a financial advisor to assist with the evaluation of these strategic alternatives. There can be no assurance that the strategic review process will result in any transaction.
As more fully described in the notes to our condensed consolidated financial statements, on December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“TCJA”) was signed by the U.S. President. The TCJA significantly changes the income tax environment for U.S. multinational corporations and as such, the Company recorded additional income tax expense of $12,720 during the nine months ended March 31, 2018.
Despite the difficult generic pharmaceutical industry environment, our financial position as of March 31, 2018 remains strong, as we had cash and cash equivalents and short-term investments of $65,091 and working capital of $52,446.
Our business is separated into three principal segments: Human Health, Pharmaceutical Ingredients and Performance Chemicals.
Products that fall within the Human Health segment include finished dosage form generic drugs and nutraceutical products. Aceto sells generic prescription products and over-the-counter pharmaceutical products to leading wholesalers, chain drug stores, distributors and mass merchandisers. As previously mentioned, given continued headwinds in the generics market, the Company recorded a goodwill impairment charge of $235,110 in the Rising business segment in the third quarter of fiscal 2018.
On December 21, 2016, Rising completed the acquisition of certain generic products and related assets of entities formerly known as Citron Pharma LLC (“Citron”) and its affiliate Lucid Pharma LLC (“Lucid”). Rising formed two subsidiaries to consummate the product acquisition – Rising Health, LLC (which acquired certain products and related assets of Citron) and Acetris Health, LLC (which acquired certain products and related assets of Lucid). Citron was a privately-held New Jersey-based pharmaceutical company focused on developing and marketing generic pharmaceutical products in partnership with leading generic pharmaceutical manufacturers based in India and the U.S. Lucid was a privately-held New Jersey-based generic pharmaceutical distributor specializing in providing cost-effective products to various agencies of the U.S. Federal Government including the Veterans Administration and the Defense Logistics Agency. Lucid serviced 18 national contracts with the Federal Government, nearly all of which had 5-year terms. In February 2018, Aceto was notified by the U.S. government that 11 generic drug products are not in compliance with the federal Trade Agreement Act (“TAA”) country-of-origin provisions of a clause contained in the government supply contracts. See Note 8 to the Company’s Condensed Consolidated Financial Statements. The 11 finished dosage form products purchased by the U.S. government are manufactured by Aurolife Pharma LLC which is located in Dayton, New Jersey using APIs sourced from India. Based on this notification, the Company recorded an impairment charge of $15,411 on the customer relationships intangible asset in the third quarter of fiscal 2018.
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The assets acquired in the product purchase transaction expanded, complemented, and strengthened our existing and future product offerings. In what has become a competitive generic drug business environment, one key for long-term success is having an ever-growing commercial portfolio of generic products, a strong internal drug development pipeline and capable, reliable manufacturing partners. This transaction added significantly to the Rising business platform in all three crucial areas. We believe that, consistent with our strategy of expanding our portfolio of finished dosage form generic products through product development partnerships and acquisitions of late stage assets, abbreviated new drug applications (“ANDAs”) and complementary generic drug businesses, this product acquisition significantly expanded our roster of commercialized products and pipeline of products under development.
Based on a report issued by IQVIA Institute on April 19, 2018, “Spending on medicines grew by 0.6% in 2017 after off-invoice discounts and rebates. This spending includes all types of medicines, including institutional use for inpatients and outpatients. Focusing only on retail and mail-order pharmacy distribution, net spending declined by 2.1%.”
Aceto supplies the raw materials used in the production of nutritional and packaged dietary supplements, including vitamins, amino acids, iron compounds and biochemicals used in pharmaceutical and nutritional preparations.
The Pharmaceutical Ingredients segment has two product groups: Active Pharmaceutical Ingredients (APIs) and Pharmaceutical Intermediates.
We supply APIs to many of the major generic drug companies, who we believe view Aceto as a valued partner in their effort to develop and market generic drugs. The process of introducing a new API from pipeline to market spans a number of years and begins with Aceto partnering with a generic pharmaceutical manufacturer and jointly selecting an API, several years before the expiration of a composition of matter patent, for future genericizing. We then identify the appropriate supplier, and concurrently utilizing our global technical network, work to ensure they meet standards of quality to comply with regulations. Our client, the generic pharmaceutical company, will submit the ANDA for U.S. Food and Drug Administration (“FDA”) approval or European-equivalent approval. The introduction of the API to market occurs after all the development testing has been completed and the ANDA or European-equivalent is approved and the patent expires or is deemed invalid. Aceto, at all times, has a pipeline of APIs at various stages of development both in the United States and Europe. Additionally, as the pressure to lower the overall cost of healthcare increases, Aceto has focused on, and works very closely with our customers to develop new API opportunities to provide alternative, more economical, second-source options for existing generic drugs. By leveraging our worldwide sourcing, regulatory and quality assurance capabilities, we provide to generic drug manufacturers an alternative, economical source for existing API products.
Aceto has long been a supplier of pharmaceutical intermediates, the complex chemical compounds that are the building blocks used in producing APIs. These are the critical components of all drugs, whether they are already on the market or currently undergoing clinical trials. Faced with significant economic pressures as well as ever-increasing regulatory barriers, the innovative drug companies look to Aceto as a source for high quality intermediates.
Aceto employs, on occasion, the same second source strategy for our pharmaceutical intermediates business that we use in our API business. Historically, pharmaceutical manufacturers have had one source for the intermediates needed to produce their products. Utilizing our global sourcing, regulatory support and quality assurance network, Aceto works with the large, global pharmaceutical companies, sourcing lower cost, quality pharmaceutical intermediates that will meet the same high level standards that their current commercial products adhere to.
The Performance Chemicals segment includes specialty chemicals and agricultural protection products.
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Aceto is a major supplier to many different industrial segments providing chemicals used in the manufacture of plastics, surface coatings, cosmetics and personal care, textiles, fuels and lubricants. The paint and coatings industry produces products that bring color, texture, and protection to houses, furniture, packaging, paper, and durable goods. Many of today's coatings are eco-friendly, by allowing inks and coatings to be cured by ultraviolet light instead of solvents, or allowing power coatings to be cured without solvents. These growing technologies are critical in protecting and enhancing the world's ecology and Aceto is focused on supplying the specialty additives that make modern coating techniques possible.
The chemistry that makes much of the modern world possible is often done by building up simple molecules to sophisticated compounds in step-by-step chemical processes. The products that are incorporated in each step are known as intermediates and they can be as varied as the end uses they serve, such as crop protection products, dyes and pigments, textiles, fuel additives, electronics - essentially all things chemical.
Aceto provides various specialty chemicals for the food, flavor, fragrance, paper and film industries. Aceto’s raw materials are also used in sophisticated technology products, such as high-end electronic parts used for photo tooling, circuit boards, production of computer chips, and in the production of many of today's modern gadgets.
According to an April 17, 2018 Federal Reserve Statistical Release, in the first quarter of calendar year 2018, the index for consumer durables, which impacts the Specialty Chemicals business of the Performance Chemicals segment, is expected to increase at an annual rate of 7.8%.
Aceto’s agricultural protection products include herbicides, fungicides and insecticides, which control weed growth as well as the spread of insects and microorganisms that can severely damage plant growth. One of Aceto's most widely used agricultural protection products is a sprout inhibitor that extends the storage life of potatoes. Utilizing our global sourcing and regulatory capabilities, we identify and qualify manufacturers either producing the product or with knowledge of the chemistry necessary to produce the product, and then file an application with the U.S. EPA for a product registration. Aceto has an ongoing working relationship with manufacturers in China and India to determine which of the non-patented or generic, agricultural protection products they produce can be effectively marketed in the Western world. We have successfully brought numerous products to market. We have a strong pipeline, which includes future additions to our product portfolio. The combination of our global sourcing and regulatory capabilities makes the generic agricultural market a niche for us and we will continue to offer new product additions in this market. In the National Agricultural Statistics Services release dated June 30, 2017, the total crop acreage planted in the United States in 2017 decreased by .3% to 318 million acres from 319 million acres in 2016. The number of peanut acres planted in 2017 increased 8.8% from 2016 levels while sugarcane acreage harvested decreased 3.4% from 2016. In addition, the potato acreage harvested in 2017 increased approximately .7% from the 2016 level.
We believe our main business strengths are sourcing, regulatory support, quality assurance, marketing and distribution. We distribute more than 1,100 chemical compounds used principally as finished products or raw materials in the pharmaceutical, nutraceutical, agricultural, coatings and industrial chemical industries. With business operations in ten countries, we believe that our global reach is distinctive in the industry, enabling us to source and supply quality products on a worldwide basis. Leveraging local professionals, we source approximately two-thirds of our products from Asia, buying from approximately 500 companies in China and 200 in India.
In this MD&A, we explain our general financial condition and results of operations, including, among other things, the following:
| · | factors that affect our business |
| · | our earnings and costs in the periods presented |
| · | changes in earnings and costs between periods |
| · | sources of earnings |
| · | the impact of these factors on our overall financial condition |
As you read this MD&A section, refer to the accompanying condensed consolidated statements of operations, which present the results of our operations for the three and nine months ended March 31, 2018 and 2017. We analyze and explain the differences between periods in the specific line items of the condensed consolidated statements of operations.
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Critical Accounting Estimates and Policies
As disclosed in our 2017 10-K, the discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. In preparing these financial statements, we were required to make estimates and assumptions that affect the amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We regularly evaluate our estimates including those related to allowances for bad debts, revenue recognition, partnered products, inventories, goodwill and indefinite-life intangible assets, long-lived assets, environmental and other contingencies, income taxes, stock-based compensation and purchase price allocation. We base our estimates on various factors, including historical experience, advice from outside subject-matter experts, and various assumptions that we believe to be reasonable under the circumstances, which together form the basis for our making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. Since June 30, 2017, there have been no significant changes to the assumptions and estimates related to those critical accounting estimates and policies. We are planning to implement a new enterprise resource planning (“ERP”) system at our Rising subsidiary during the fourth quarter of our current fiscal year. In automating processes that heretofore have been undertaken manually, we may be required to reassess certain of our estimates, especially with respect to our rebates, returns and chargebacks approaches.
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RESULTS OF OPERATIONS
Nine Months Ended March 31, 2018 Compared to Nine Months Ended March 31, 2017
Net Sales by Segment Nine months ended March 31, | ||||||||||||||||||||||||
| Comparison 2018 | ||||||||||||||||||||||||
| 2018 | 2017 | Over/(Under) 2017 | ||||||||||||||||||||||
| % of | % of | $ | % | |||||||||||||||||||||
| Segment | Net sales | Total | Net sales | Total | Change | Change | ||||||||||||||||||
| Human Health | $ | 301,407 | 55.6 | % | $ | 201,686 | 45.5 | % | $ | 99,721 | 49.4 | % | ||||||||||||
| Pharmaceutical Ingredients | 113,406 | 20.9 | 121,253 | 27.3 | (7,847 | ) | (6.5 | ) | ||||||||||||||||
| Performance Chemicals | 127,669 | 23.5 | 120,759 | 27.2 | 6,910 | 5.7 | ||||||||||||||||||
| Net sales | $ | 542,482 | 100.0 | % | $ | 443,698 | 100.0 | % | $ | 98,784 | 22.3 | % | ||||||||||||
Gross Profit by Segment Nine months ended March 31, | ||||||||||||||||||||||||
| Comparison 2018 | ||||||||||||||||||||||||
| 2018 | 2017 | Over/(Under) 2017 | ||||||||||||||||||||||
| Gross | % of | Gross | % of | $ | % | |||||||||||||||||||
| Segment | Profit | Sales | Profit | Sales | Change | Change | ||||||||||||||||||
| Human Health | $ | 57,080 | 18.9 | % | $ | 56,424 | 28.0 | % | $ | 656 | 1.2 | % | ||||||||||||
| Pharmaceutical Ingredients | 17,259 | 15.2 | 19,867 | 16.4 | (2,608 | ) | (13.1 | ) | ||||||||||||||||
| Performance Chemicals | 27,310 | 21.4 | 27,672 | 22.9 | (362 | ) | (1.3 | ) | ||||||||||||||||
| Gross profit | $ | 101,649 | 18.7 | % | $ | 103,963 | 23.4 | % | $ | (2,314 | ) | (2.2 | )% | |||||||||||
Net Sales
Net sales increased $98,784, or 22.3%, to $542,482 for the nine months ended March 31, 2018, compared with $443,698 for the prior period. We reported sales increases in our Human Health and Performance Chemicals segments and a decrease in our Pharmaceutical Ingredients segment.
Human Health
Net sales for the Human Health segment increased by $99,721 for the nine months ended March 31, 2018, to $301,407, which represents a 49.4% increase over net sales of $201,686 for the prior period. The primary reason for the increase is due to the acquisition of certain products and related assets of Citron and Lucid. Sales from the product acquisition of $161,138 are included in the nine months ended March 31, 2018 compared to $57,134 included in the nine months ended March 31, 2017. In addition, there was a rise of $3,221 in sales of nutritional products, sold abroad, primarily by our German subsidiary. These increases in Human Health were offset in part, by a decline in sales of certain currently marketed and pipeline generic products as a result of continued pricing pressure, intense competition and related consolidation of customers and softer than expected contributions from new product launches. In addition, Rising incurred approximately $12,903 in failure to supply penalties primarily related to supply challenges with regards to products acquired from Citron and Lucid.
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Pharmaceutical Ingredients
Net sales for the Pharmaceutical Ingredients segment decreased $7,847 or 6.5% to $113,406 when compared to the prior period net sales of $121,253. The decrease in sales for this segment was due primarily to a decline in sales of domestic APIs of $7,096, mainly due to reduced orders of a customer-launched API, timing of sales of three products that are expected to be shipped in the fourth quarter of fiscal year 2018, delayed customer launch of an API, competition on another API and the discontinuance of two finish dosage drugs sold by our API business unit. These decreases in domestic APIs were offset in part by an increase of $2,135 of APIs sold abroad, specifically in Germany. Sales of intermediates sold both domestically and abroad decreased $2,886 from the prior period primarily occurring in France, due to delays in shipments.
Performance Chemicals
Net sales for the Performance Chemicals segment was $127,669 for the nine months ended March 31, 2018, representing an increase of $6,910 or 5.7%, from net sales of $120,759 for the prior period. The Specialty Chemicals business experienced a rise in sales of $10,937 over the prior period. The rise in Specialty Chemicals sales is partly due to an increase in domestic sales of $6,765, primarily from increased sales of agricultural and miscellaneous intermediates as well as surface coatings. In addition, sales of specialty chemical products sold abroad, increased $4,172 over the prior period, predominantly at our subsidiaries in Germany and France. Performance Chemicals sales were impacted by a $4,027 drop in sales of our agricultural protection products, predominantly from a decline in sales of an herbicide used to treat weeds on vegetables. In addition, sales of an insecticide used on cotton has decreased as orders have been pushed to the fourth quarter of fiscal 2018 and the first quarter of fiscal 2019.
Gross Profit
Gross profit decreased $2,314 to $101,649 (18.7% of net sales) for the nine months ended March 31, 2018, as compared to $103,963 (23.4% of net sales) for the prior period.
Human Health
Human Health segment’s gross profit of $57,080 for the nine months ended March 31, 2018 increased $656, or 1.2%, over the prior period. The gross margin of 18.9% was lower than the prior period’s gross margin of 28.0%. The decline in gross margin is primarily driven by unfavorable product mix on certain Rising products, continued pricing pressure, intense competition and related consolidation of customers and failure to supply charges.
Pharmaceutical Ingredients
Pharmaceutical Ingredients’ gross profit of $17,259 for the nine months ended March 31, 2018 decreased $2,608, or 13.1%, over the prior period. The gross margin of 15.2% was lower than the prior period’s gross margin of 16.4%. The decrease in gross profit and gross margin was predominantly the result of the decrease in the sales volume of APIs sold domestically, as well as a drop in reorders of a certain API which typically yields a significantly higher gross margin. In addition, our international subsidiaries experienced an unfavorable product mix on API sales.
Performance Chemicals
Gross profit for the Performance Chemicals segment decreased to $27,310 for the nine months ended March 31, 2018, versus $27,672 for the prior year, a decrease of $362 or 1.3%. The gross margin at 21.4% for the nine months ended March 31, 2018 was lower than the prior year’s gross margin of 22.9%. The decrease in gross profit was due to a $1,858 decline in gross profit for the Agricultural Protection Products business, as a result of the sales volume decline, partially offset by an increase in gross profit of $1,496 on the sales volume increase of sales of Specialty Chemicals. The drop in gross margin from the prior period is a result of an unfavorable product mix on sales of specialty chemical products sold domestically.
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Selling, General and Administrative Expenses
SG&A of $87,241 for the nine months ended March 31, 2018 increased $11,627 or 15.4% from $75,614 reported for the prior period. As a percentage of sales, SG&A decreased to 16.1% for the nine months ended March 31, 2018 versus 17.0% in the prior period. SG&A for the current period included $15,884of amortization expense associated with the purchased intangible assetsrelated to the product purchase compared to $6,030 in the prior period. In fiscal 2018, we recorded $4,064 of one-time costs associated with the separation of the Company’s former Chief Executive Officer, including $2,017 of stock-based compensation. The increase in SG&A is also due to an increase in consulting fees of $1,610 which includes consulting services provided by former Citron and Lucid employees in connection with the Transition Services Agreement associated with the product purchase agreement and outsourcing fees related to the accounting processes of Rising Health and Acetris Health. In addition, SG&A rose due to an increase in professional fees of $3,433 and an increase in payroll and related fringe benefits of $1,721, due primarily to annual merit increases as well as the hiring of certain key management personnel. The increase in SG&A was offset in part by a reduction of $2,505 in the contingent consideration liability related to the acquisition of certain assets of Citron. SG&A for the prior period included $8,818 of transaction costs related to the product purchase agreement.
Impairment Charges
During the nine months ended March 31, 2018, the Company recorded impairment charges of $256,266, all of which related to the Rising business segment. The impairment charges consisted of $235,110 of goodwill impairment charges and a $21,156 write-down of other identifiable intangible assets. For additional information regarding these impairment charges, see Note 9 to the Company’s Condensed Consolidated Financial Statements. There were no impairment charges recorded in the nine months ended March 31, 2017.
Research and Development Expenses
Research and development expenses (“R&D”) increased to $6,208 for the nine months ended March 31, 2018 compared to $4,998 for the prior period. R&D expenses represent investment in our generic finished dosage form product pipeline. The majority of the R&D expenses are milestone based, which was the primary cause for such increase and will likely cause fluctuation from quarter to quarter.
Operating (Loss) Income
For the nine months ended March 31, 2018, operating loss was $(248,066) compared to operating income of $23,351 in the prior period, a decrease of $271,417 primarily due to the impairment charges recorded in fiscal 2018.
Interest Expense
Interest expense was $15,443 for the nine months ended March 31, 2018, an increase of $5,220 or 51.1% from the prior period. The increase was primarily due tointerest expense associated with the Second Amended and RestatedCredit Agreement, which was entered on December 21, 2016 to help fund our product acquisition, as well as additional interest associated with the$50,000 unsecured deferred paymentrelated to the product acquisition.
Interest and Other Income, Net
Interest and other income, net was $2,111 for the nine months ended March 31, 2018, an increase of $881 from the prior period, primarily due to increases in unrealized foreign exchange gains from mark-to-market valuation of foreign currency futures contracts and an increase in income related to a joint venture for one of our agricultural protection products.
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Provision for Income Taxes
The effective tax rate for the nine months ended March 31, 2018 was (7.7)% compared to expense of 34.5% for the prior period. During the nine months ended March 31, 2018, the Company recorded a valuation allowance of $71,350 against its U.S. deferred tax assets. For additional information, see Notes 2 and 12 to the Company’s Condensed Consolidated Financial Statements. In accordance with the TCJA, for the nine months ended March 31, 2018, we recorded additional income tax expense of $12,720. In addition, we recorded $1,521 of additional income tax expense associated with net tax deficiencies under ASU 2016-09, which was adopted prospectively in the first quarter of fiscal 2018. We expect the substantially lower corporate tax rate reflected in the TCJA to benefit our financial results and cash flow in future periods.
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Three Months Ended March 31, 2018 Compared to Three Months Ended March 31, 2017
Net Sales by Segment Three months ended March 31, | ||||||||||||||||||||||||
| Comparison 2018 | ||||||||||||||||||||||||
| 2018 | 2017 | Over/(Under) 2017 | ||||||||||||||||||||||
| % of | % of | $ | % | |||||||||||||||||||||
| Segment | Net sales | Total | Net sales | Total | Change | Change | ||||||||||||||||||
| Human Health | $ | 91,926 | 49.4 | % | $ | 99,816 | 52.5 | % | $ | (7,890 | ) | (7.9 | )% | |||||||||||
| Pharmaceutical Ingredients | 43,201 | 23.2 | 43,821 | 23.0 | (620 | ) | (1.4 | ) | ||||||||||||||||
| Performance Chemicals | 50,871 | 27.4 | 46,491 | 24.5 | 4,380 | 9.4 | ||||||||||||||||||
| Net sales | $ | 185,998 | 100.0 | % | $ | 190,128 | 100.0 | % | $ | (4,130 | ) | (2.2 | )% | |||||||||||
Gross Profit by Segment Three months ended March 31, | ||||||||||||||||||||||||
| Comparison 2018 | ||||||||||||||||||||||||
| 2018 | 2017 | Over/(Under) 2017 | ||||||||||||||||||||||
| Gross | % of | Gross | % of | $ | % | |||||||||||||||||||
| Segment | Profit | Sales | Profit | Sales | Change | Change | ||||||||||||||||||
| Human Health | $ | 9,535 | 10.4 | % | $ | 25,300 | 25.3 | % | $ | (15,765 | ) | (62.3 | )% | |||||||||||
| Pharmaceutical Ingredients | 7,038 | 16.3 | 7,255 | 16.6 | (217 | ) | (3.0 | ) | ||||||||||||||||
| Performance Chemicals | 11,123 | 21.9 | 9,764 | 21.0 | 1,359 | 13.9 | ||||||||||||||||||
| Gross profit | $ | 27,696 | 14.9 | % | $ | 42,319 | 22.3 | % | $ | (14,623 | ) | (34.6 | )% | |||||||||||
Net Sales
Net sales decreased $4,130 or 2.2%, to $185,998 for the three months ended March 31, 2018, compared with $190,128 for the prior period. We reported a sales increase in our Performance Chemicals segment and decreases in our Pharmaceutical Ingredients and Human Health segments.
Human Health
Net sales for the Human Health segment decreased by $7,890 for the three months ended March 31, 2018, to $91,926, which represents a 7.9% decrease compared to net sales of $99,816 for the prior period. The primary reason for the decrease is due to $8,148 decline in sales of Rising products as a result of continued pricing pressure, intense competition and related consolidation of customers and softer than expected contributions from new product launches. We believe these generic industry headwinds will continue in the near term. In addition, Rising incurred approximately $10,132 in failure to supply penalties primarily related to supply challenges with regards to products acquired from Citron and Lucid.
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Pharmaceutical Ingredients
Net sales for the Pharmaceutical Ingredients segment decreased $620 or 1.4% to $43,201 when compared to the prior period net sales of $43,821. The decrease in sales for this segment was due primarily to a decline in sales of intermediates of $1,091 sold domestically. This decline is partially offset by an increase in sales of APIs, mainly experienced by our German subsidiaries.
Performance Chemicals
Net sales for the Performance Chemicals segment was $50,871 for the three months ended March 31, 2018, representing an increase of $4,380 or 9.4%, from net sales of $46,491 for the prior period. Performance Chemicals sales were impacted by a $1,472 increase in sales of our agricultural protection products, predominantly from an increase in sales of a fungicide used to prevent disease on pecan crops. Performance Chemicals also experienced a rise of $2,908 in Specialty Chemicals sales predominantly due to increased sales of surface coatings of $1,178. In addition, sales of specialty chemical products sold abroad, increased $1,625 over the prior period, predominantly at our subsidiaries in Germany and France.
Gross Profit
Gross profit decreased $14,623 to $27,696 (14.9% of net sales) for the three months ended March 31, 2018, as compared to $42,319 (22.3% of net sales) for the prior period.
Human Health
Human Health segment’s gross profit of $9,535 for the three months ended March 31, 2018 decreased $15,765, or 62.3%, over the prior period. The gross margin of 10.4% was lower than the prior period’s gross margin of 25.3%. The decline in gross profit and gross margin was primarily driven by unfavorable product mix on certain Rising products, continued pricing pressure, intense competition and related consolidation of customers and failure to supply charges.
Pharmaceutical Ingredients
Pharmaceutical Ingredients’ gross profit of $7,038 for the three months ended March 31, 2018 was relatively flat compared to the prior period gross profit of $7,255. The gross margin of 16.3% was consistent to the prior period’s gross margin of 16.6%.
Performance Chemicals
Gross profit for the Performance Chemicals segment increased to $11,123 for the three months ended March 31, 2018, versus $9,764 for the prior year, an increase of $1,359 or 13.9%. The gross margin at 21.9% for the three months ended March 31, 2018 was higher than the prior year’s gross margin of 21.0%. The increase in gross profit was due to sales volume increases in both the Specialty Chemicals and Agricultural Protection Products businesses. The increase in gross margin from the prior period is a result of a favorable product mix on sales of specialty chemical products sold in Germany.
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Selling, General and Administrative Expenses
SG&A of $28,029 for the three months ended March 31, 2018 increased $1,510 or 5.7% from $26,519 reported for the prior period. As a percentage of sales, SG&A increased to 15.1% for the three months ended March 31, 2018 versus 13.9% in the prior period. The increase in SG&A is primarily due to an increase in professional fees of $2,484, an increase in payroll and related fringe benefits of $1,801 due primarily to annual merit increases as well as the hiring of certain key management personnel offset by a reduction of $2,505 in the contingent consideration liability related to the acquisition of certain assets of Citron.
Impairment Charges
During the three months ended March 31, 2018, the Company recorded impairment charges of $256,266, all of which related to the Rising business segment. The impairment charges consisted of $235,110 of goodwill impairment charges and $21,156 write-down of other identifiable intangible assets. For additional information regarding these impairment charges, see Note 9 to the Company’s Condensed Consolidated Financial Statements. There were no impairment charges recorded in the three months ended March 31, 2017.
Research and Development Expenses
R&D expenses decreased to $2,471 for the three months ended March 31, 2018 compared to $2,607 for the prior period. The majority of the R&D expenses are milestone based, which was the primary cause for such decrease and will likely cause fluctuation from quarter to quarter.
Operating Income
For the three months ended March 31, 2018 operating (loss) income was $(259,070) compared to $13,193 in the prior period, a decrease of $272,263 primarily due to the impairment charges recorded in fiscal 2018.
Provision for Income Taxes
The effective tax rate for the three months ended March 31, 2018 was (1.9)% compared to expense of 34.4% for the prior period. During the three months ended March 31, 2018, the Company recorded a valuation allowance of $71,350 against its U.S. deferred tax assets. For additional information, see Notes 2 and 12 to the Company’s Condensed Consolidated Financial Statements. For the three months ended March 31, 2018, we recorded $1,189 of income tax benefit associated with the TCJA. In addition, we recorded $420 of additional income tax expense associated with net tax deficiencies under ASU 2016-09, which was adopted prospectively in the first quarter of fiscal 2018. We expect the substantially lower corporate tax rate associated with the TCJA to benefit our financial results and cash flow in future periods.
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Liquidity and Capital Resources
Cash Flows
At March 31, 2018, we had $62,032 in cash, of which $17,293 was outside the United States, $3,059 in short-term investments, all of which is held outside the United States, and $319,420 in long-term debt (including the current portion), all of which is an obligation in the United States. Working capital was $52,446 at March 31, 2018 compared to $248,750 at June 30, 2017. The significant reduction in working capital at March 31, 2018 reflects the reclassification of our term debt and revolver debt into current liabilities. See Note 7 of the Notes to the Company’s Condensed Consolidated Financial Statements. The $17,293 of cash held outside of the United States is fully accessible to meet any liquidity needs of our business located in any of the countries in which we operate. The majority of the cash located outside of the United States is held by our European and Chinese operations and can be transferred into the United States. Although these amounts are fully accessible, transferring these amounts into the United States or any other countries could have certain local tax consequences. In accordance with the TCJA, we recorded $2,366 of additional income tax expense related to deferred tax liabilities for local tax authorities as we no longer assert permanent reinvestment of our undistributed non-U.S. subsidiaries' earnings. A portion of our cash is held in operating accounts that are with third party financial institutions. While we monitor daily the cash balances in our operating accounts and adjust the cash balances as appropriate, these cash balances could be impacted if the underlying financial institutions fail or are subject to other adverse conditions in the financial markets. To date, we have experienced no loss or lack of access to cash in our operating accounts.
Our cash position at March 31, 2018 increased $6,352 from the amount at June 30, 2017. Operating activities for the nine months ended March 31, 2018 provided cash of $56,415 for this period, as compared to cash provided of $31,551 for the comparable prior period. The $56,415 resulted from $281,395 in net loss, $301,178 derived from adjustments for non-cash items and a net $36,632 increase from changes in operating assets and liabilities. The non-cash items included $256,266 in goodwill and intangible asset impairment charges, $24,608 in depreciation and amortization expense, $11,714 of deferred income tax expense, a $902 environmental charge, $4,603 for amortization of debt issuance costs and debt discount, and $6,442 in non-cash stock compensation expense, offset in part by $1,990 of earnings on an equity investment in a joint venture and a $2,505 reversal of contingent consideration. Trade accounts receivable decreased $2,573 during the nine months ended March 31, 2018, due predominantly to a decrease in days sales outstanding, particularly at our Rising subsidiary. Inventories increased by $3,102 and accounts payable increased by $34,224 due primarily to increased inventories held in stock by our Agricultural Protection Products subsidiary for the anticipated shipments in the fourth quarter of fiscal 2018 as well as timing of payments processed at the end of the quarter. Inventories also increased as a result of a build-up of Specialty Chemicals inventory. Other receivables increased $3,662 due primarily to an increase in value added taxes receivables for our German subsidiaries, as well as income taxes due to the Company. Accrued expenses and other liabilities increased $9,728 due primarily to a rise in price concessions for our Rising business as well as the timing of income tax payments. Our cash position at March 31, 2017 decreased $6,866 from the amount at June 30, 2016. Operating activities for the nine months ended March 31, 2017 provided cash of $31,551 for this period. The $31,551 resulted from $9,409 in net income, $25,149 derived from net adjustments for non-cash items and a net $3,007 decrease from changes in operating assets and liabilities.
Investing activities for the nine months ended March 31, 2018 used cash of $6,469 primarily from purchases of property and equipment and intangible assets of $5,456 and purchases of investments in time deposits of $2,880, partially offset by sales of investments in time deposits of $1,867. Investing activities for the nine months ended March 31, 2017 used cash of $275,512 primarily from $270,000 of payments for the product acquisition and purchases of intangible assets and property and equipment of $4,463 and purchases of investments in time deposits of $1,824.
Financing activities for the nine months ended March 31, 2018 used cash of $44,727 primarily from $39,398 of repayments of bank loans and $5,924 in payment of cash dividends. Financing activities for the nine months ended March 31, 2017 provided cash of $237,852, primarily from bank borrowings of $265,000. Financing activities included $16,898 of repayments of bank loans, $5,944 in payment of cash dividends and $5,407 for payment of deferred financing costs offset in part by $550 of proceeds received from stock option exercises and $551 of excess income tax benefits on stock option exercises and restricted stock vestings.
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Credit Facilities
We have available credit facilities with certain foreign financial institutions. At March 31, 2018, the Company had available lines of credit with foreign financial institutions totaling $7,929, all of which is available for borrowing by the respective foreign territories. We are not subject to any financial covenants under these arrangements.
On December 21, 2016 the Company entered into a Second Amended and Restated Credit Agreement (the “A&R Credit Agreement”), with eleven banks, which amended and restated in its entirety the Amended and Restated Credit Agreement, dated as of October 28, 2015, as amended by Amendment No. 1 to Amended and Restated Credit Agreement, dated as of November 10, 2015, and Amendment No. 2 to Amended and Restated Credit Agreement, dated as of August 26, 2016 (collectively, the “First Amended Credit Agreement”). The A&R Credit Agreement increased the aggregate available revolving commitment under the First Amended Credit Agreement from $150,000 to an initial aggregate available revolving commitment of $225,000 (the “Initial Revolving Commitment”). Under the A&R Credit Agreement, the Company may borrow, repay and reborrow from and as of December 21, 2016, to but excluding December 21, 2021 (the “Maturity Date”) provided, that if any of the Notes remain outstanding on the date that is 91 days prior to the maturity date of the Notes (the “2015 Convertible Maturity Date”), then the Maturity Date shall mean the date that is 91 days prior to the 2015 Convertible Maturity Date. The A&R Credit Agreement provides for (i) Eurodollar Loans (as such terms are defined in the A&R Credit Agreement), (ii) ABR Loans (as such terms are defined in the A&R Credit Agreement) or (iii) a combination thereof. As of March 31, 2018, the Company borrowed Revolving Loans (as defined under the A&R Credit Agreement) aggregating $62,000 which loans are Eurodollar Loans at interest rates ranging from 3.57% to 3.63% at March 31, 2018. The applicable interest rate margin percentage is subject to adjustment quarterly based upon the Company’s senior secured net leverage ratio.
Under the A&R Credit Agreement, the Company also borrowed $150,000 in term loans (the “Initial Term Loan). Subject to certain conditions, including obtaining commitments from existing or prospective lenders, the Company had the right to increase the amount of the Initial Revolving Commitment (each, a “Revolving Facility Increase” and, together with the Initial Revolving Commitment, the “Revolving Commitment”) and/or the Initial Term Loan in an aggregate amount not to exceed $100,000 pursuant to an incremental loan feature in the A&R Credit Agreement. As of March 31, 2018, the remaining amount outstanding under the Initial Term Loan was $131,250 and was payable as a Eurodollar Loan at an interest rate of 4.05%. The proceeds of the Initial Revolving Commitment and Initial Term Loan were used to partially finance the acquisition of generic products and related assets of Citron and its affiliate Lucid, and pay fees and expenses related thereto. The applicable interest rate margin percentage is subject to adjustment quarterly based upon the Company’s senior secured net leverage ratio.
The Initial Term Loan is payable as to principal in nineteen consecutive, equal quarterly installments of $3,750, which commenced on March 31, 2017 and will continue on each March 31, June 30, September 30 and December 31 thereafter. To the extent not previously paid, the final payment on the Term Loan Maturity Date (as defined in the A&R Credit Agreement) shall be in an amount equal to the then outstanding unpaid principal amount of the Initial Term Loan.
The A&R Credit Agreement, provides that commercial letters of credit shall be issued to provide the primary payment mechanism in connection with the purchase of any materials, goods or services in the ordinary course of business. The Company had no open letters of credit at March 31, 2018 and June 30, 2017.
In accordance with generally accepted accounting principles, deferred financing costs associated with the Initial Term Loan are presented as a direct deduction from the carrying value of the debt liability rather than showing the deferred financing costs as a deferred charge on the balance sheet. In addition, deferred financing costs associated with the Revolving Commitment have been recorded as a deferred charge on the balance sheet.
The A&R Credit Agreement provides for a security interest in substantially all of the personal property of the Company and certain of its subsidiaries. The A&R Credit Agreement contains several financial covenants including, among other things, maintaining a minimum level of debt service and certain leverage ratios. Under the A&R Credit Agreement, the Company and its subsidiaries are also subject to certain restrictive covenants, including, among other things, covenants governing liens, limitations on indebtedness, limitations on guarantees, limitations on sales of assets and sales of receivables, and limitations on loans and investments.
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On December 13, 2017, the Company entered into a First Amendment to the Second Amended and Restated Credit Agreement (the “2017 Amendment”), which amended the A&R Credit Agreement. The 2017 Amendment, among other things, contained several amendments to the financial covenants in the A&R Credit Agreement.
As of March 31, 2018, the Company was in compliance with all of its financial covenants except for the maximum total net leverage ratio and the minimum debt service coverage ratio. On May 3, 2018, the Company entered into a Second Amendment and Waiver to the Second Amended and Restated Credit Agreement (the “2018 Amendment”). The 2018 Amendment, among other things, contains a waiver of any event of default under the A&R Credit Agreement arising as a result of the non-compliance by the Company with the Total Net Leverage Ratio and Debt Service Coverage Ratio financial covenants, in each case, solely for the fiscal quarter ended March 31, 2018. The Amendment also contains several amendments to the A&R Credit Agreement including, among other things, (a) reducing the available revolving commitment thereunder to $100,000, and (b) during the period commencing on the closing of the 2018 Amendment and ending on the date the Company demonstrates compliance with each financial covenant set forth in the A&R Credit Agreement for the fiscal quarter ending June 30, 2018 (the “Limitation Period”; provided that if the Company is not in compliance with any of the financial covenants set forth in the A&R Credit Agreement for the fiscal quarter ending June 30, 2018, then the Limitation Period shall continue indefinitely): (i) fixing the applicable margin with respect to all loans under the A&R Credit Agreement to the highest level provided under the A&R Credit Agreement, which is 1.50% in the case of ABR Loans (as defined in the A&R Credit Agreement) and 2.50% in the case of Eurodollar Loans (as defined in the A&R Credit Agreement), (ii) fixing the commitment fee on the undrawn revolving commitments under the A&R Credit Agreement to the highest level provided under the A&R Credit Agreement which is 0.40% per annum, (iii) requiring the prior written consent of the Required Lenders (as defined in the A&R Credit Agreement) as a condition precedent to the lenders extending any Loans (as defined in the A&R Credit Agreement) or the issuing banks issuing, amending, renewing or extending any Letter of Credit (as defined in the A&R Credit Agreement), (iv) restricting the amount of dividends or distributions the Company may make to its shareholders to no more than $0.01 per share for the fiscal quarter ending on June 30, 2018 and, during the Limitation Period, restricting the Company from making any other dividends or distributions to its shareholders thereafter and (v) restricting the incurrence of certain indebtedness, limiting acquisitions and other investments and imposing certain other restrictions.
In accordance with GAAP, we have classified theindebtedness outstanding under the Company’s credit facility as a current liability as of March 31, 2018. This differs from the customary treatment heretofore applicable to indebtedness outstanding under the Company’s credit facility, in which only the portion of such indebtedness payable within one year from the balance sheet date has been recorded as a current liability. The waiver that the Company has received from its lenders under the credit facility applies solely to the non-compliance with certain financial covenants as of March 31, 2018 and thus does not waive non-compliance with any financial covenants as of June 30, 2018. It is probable that the Company will not comply with certain financial covenants as of June 30, 2018 in the absence of a material change in the Company’s operating results. That probability is the factor that has caused the Company to reclassify its indebtedness. While the Company believes that if the Company cooperates with its lenders during the next 90 days, it is probable that the lenders will amend the financial covenants prior to June 30, 2018 or grant comparable waivers as of June 30, 2018, that probability is not sufficient to enable the Company to avoid reclassifying its indebtedness under current circumstances.
In conjunction with the Credit Agreement, the Company entered into an interest rate swap on March 21, 2017 for an additional interest cost of 2.005% on a notional amount of $100,000, which has been designated as a cash flow hedge. The expiration date of this interest rate swap is December 21, 2021. The remaining notional balance of this derivative as of March 31, 2018 is $87,500.
Working Capital Outlook
As a result of the above-mentioned reclassification of certain of the Company’s debt, working capital was $52,446 at March 31, 2018. At June 30, 2017, the Company’s working capital was $248,750. The reclassification adversely impacts the calculation of the Company’s working capital. As of March 31, 2018, the Company had current assets of $487,641 and, after giving effect to the reclassification, current liabilities of $435,195, resulting in working capital of $52,446. If the lenders’ waiver applied to June 30, 2018 as well as March 31, 2018, the Company’s current liabilities as of March 31, 2018 would have been $258,937 and the Company’s working capital would have been $228,704.
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In connection with the acquisition of certain products and related assets from Citron and Lucid, Aceto committed to make a $50,000 unsecured deferred payment that will bear interest at a rate of 5% per annum to the sellers on December 21, 2021 and to issue 5,122 shares of Aceto common stock beginning on December 21, 2019. The product purchase agreement also provides for a 5-year potential earn-out of up to an additional $50,000 in cash, based on the financial performance of four pre-specified pipeline products that are currently in development. As of March 31, 2018, the Company accrued $663 related to this contingent consideration.
In October 2015, we filed a universal shelf registration statement with the SEC to allow us to potentially offer an indeterminate principal amount and number of securities in the future with a proposed maximum aggregate offering price of up to $200,000. Under the shelf registration statement, we have the flexibility to publicly offer and sell from time to time common stock, debt securities, preferred stock, warrants and units or any combination of such securities.
In November 2015, we offered $125,000 aggregate principal amount of 2% Convertible Senior Notes due 2020 in a private offering to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended. In addition, we granted the initial purchasers for the offering an option to purchase up to an additional $18,750 aggregate principal amount pursuant to the initial purchasers’ option to purchase additional notes, which was exercised in November 2015. Therefore, the total offering was $143,750 aggregate principal amount. The remaining net proceeds received from the offering, after paying down our credit facilities and costs associated with the offering and a related hedge transaction, were used for general corporate purposes.
In connection with our agricultural protection business, we plan to continue to acquire product registrations and related data filed with the United States Environmental Protection Agency as well as payments to various task force groups, which could approximate $2,299 over the next twelve months.
In connection with our environmental remediation obligation for Arsynco, we anticipate paying $4,112 towards remediation of the property in the next twelve months, which is included in accrued expenses in our Condensed Consolidated Balance Sheet as of March 31, 2018.
As noted above, in order to obtain a waiver with respect to certain financial covenants under its credit facilities, the Company entered into the 2018 Amendment. The 2018 Amendment substantially restricts the Company’s borrowing capacity and does not provide covenant waivers with respect to any date or period after March 31, 2018. The significant decline in the market price of the Company’s common stock, and the uncertainties associated with pending legal proceedings, render it difficult for the Company to access the equity markets at the present time. The Company is also incurring substantial expenses to address the business and financial challenges previously discussed. As announced by the Company in its April 18, 2019 press release, the Company will pay a flat monthly fee of $250 for the services of its interim chief financial officer,Rebecca Roof. The Company has also retained financial and legal advisors to assist it in dealing with the various challenges that the Company is currently facing. While the Company had over $60,000 in cash as of March 31, 2018, and while its operating businesses continue to generate substantial cash, the current demands upon the Company and its liquidity are significant. As a result, the Company also announced on April 18, 2018 that it is exploring a range of strategic alternatives, including the sale of a key business segment(s), a merger or other business combination with another party, continuing as a standalone entity or other potential alternatives. We believe that our cash, liquid assets and operating cash flows willprovide us with adequate resources to fund our working capital needsfor the next twelve months.
Impact of Recent Accounting Pronouncements
In February 2018, the Financial Accounting Standards Board (“FASB”) issued ASU 2018-02,Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,which gives entities the option to reclassify the disproportionate income tax effects ("stranded tax effects") caused by the newly-enacted U.S. Tax Cuts and Jobs Act from accumulated other comprehensive income to retained earnings. The update also requires new disclosures, some of which are applicable for all entities. The guidance in ASU 2018-02 is effective for annual reporting periods beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the impact of the provisions of ASU 2018-02.
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In August 2017, the FASB issued ASU 2017-12,Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which has the objective of improving the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. In addition to that main objective, the amendments in ASU 2017-12 make certain targeted improvements to simplify the application of the hedge accounting guidance in current GAAP. The amendments in ASU 2017-12 are effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact of the provisions of ASU 2017-12.
In May 2017, the FASB issued ASU 2017-09,Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting, which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. ASU 2017-09 is effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted. The Company does not believe this new accounting standard update will have a material impact on its consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04Intangibles - Goodwill and Other (Topic 350)which would eliminate the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, the amount of an impairment charge would be recognized if the carrying amount of a reporting unit is greater than its fair value. ASU 2017-04 is effective for public companies for fiscal years beginning after December 15, 2019. The Company elected to early adopt this ASU in the third quarter of fiscal 2018. (See Note 9 to the Condensed Consolidated Financial Statements- Fair Value Measurements).
In January 2017, the FASB issued ASU 2017-01Business Combinations (Topic 805): Clarifying the Definition of a Business,with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 is effective for public companies for annual periods beginning after December 15, 2017, including interim periods within those periods. The Company does not believe this new accounting pronouncement will have a material impact on its consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15,Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which addresses eight specific cash flow issues with the objective of reducing diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company is currently evaluating the impact of the provisions of ASU 2016-15.
In March 2016, the FASB issued ASU 2016-09,Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which changes certain aspects of accounting for share-based payments to employees. The Company adopted ASU 2016-09 as of July 1, 2017. ASU 2016-09 requires that all tax benefits and deficiencies related to share-based payments be recognized and recorded through the statement of income for all awards settled or expiring after the adoption of ASU 2016-09. Under prior guidance, tax benefits in excess of compensation costs ("windfalls") were recorded in equity, and any tax deficiencies ("shortfalls") were recorded in equity to the extent of previous windfalls and then to the statement of income. For the three months and nine months ended March 31, 2018, the Company recorded additional tax expense of $420 and $1,521, respectively, associated with net tax deficiencies. ASU 2016-09 also requires, either prospectively or retrospectively, that all tax-related cash flows resulting from share-based payments be reported as operating activities on the statement of cash flows, a change from prior guidance that required windfall tax benefits to be presented as an inflow from financing activities and an outflow from operating activities on the statement of cash flows. The Company has elected to adopt such presentation on a prospective basis. Additionally, ASU 2016-09 allows entities to make an accounting policy election for the impact of most types of forfeitures on the recognition of expense for share-based payment awards by allowing the forfeitures to be either estimated, as was required under prior guidance, or recognized when they actually occur. Under ASU 2016-09, the Company recognizes forfeitures when they actually occur.
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In February 2016, the FASB issued ASU 2016-02,Leases (Topic 842) that replaces existing lease guidance. The new standard is intended to provide enhanced transparency and comparability by requiring lessees to record right-of-use assets and corresponding lease liabilities on the balance sheet. The new guidance will continue to classify leases as either finance or operating, with classification affecting the pattern of expense recognition in the statement of income. ASU 2016-02 is effective for fiscal years (and interim reporting periods within those years) beginning after December 15, 2018. The Company is currently evaluating the impact of the provisions of ASU 2016-02.
In November 2015, the FASB issued ASU 2015-17,Income Taxes (Topic 740): Balance Sheet Classification of Deferred Assets.This ASU is intended to simplify the presentation of deferred taxes on the balance sheet and requires an entity to present all deferred tax assets and deferred tax liabilities as non-current on the balance sheet. Under the prior guidance, entities were required to separately present deferred taxes as current or non-current. Netting deferred tax assets and deferred tax liabilities by tax jurisdiction will still be required under the new guidance. The Company prospectively adopted the provisions of ASU 2015-17, as of July 1, 2017. The Company's prospective adoption of ASU 2015-17 impacts the classification of deferred tax assets and liabilities on any balance sheet that reports the Company's financial position for any date after June 30, 2017. Balance sheets for prior periods have not been adjusted. The adoption of ASU 2015-17 has no impact on the Company's results of operations or cash flows.
In July 2015, the FASB issued ASU 2015-11,Inventory (Topic 330):Simplifying the Measurement of Inventory. This ASU requires that an entity measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. This guidance is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company adopted this standard in the first quarter of fiscal year 2018. The adoption of this standard did not have any impact on the condensed consolidated financial statements of the Company.
In May 2014, the FASB issued ASU 2014-09,Revenue from Contracts with Customers (Topic 606), which is the new comprehensive revenue recognition standard that will supersede all existing revenue recognition guidance under U.S. GAAP. The standard's core principle is that a company will recognize revenue when it transfers promised goods or services to a customer in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In August 2015, the FASB subsequently issued ASU 2015-14,Revenue from Contracts with Customers - Deferral of the Effective Date, which approved a one-year deferral of ASU 2014-09 for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. In March 2016 and April 2016, the FASB issued ASU 2016-08,Revenue from Contracts with Customers - Principal versus Agent Considerations (Reporting Revenue Gross versus Net), and ASU 2016-10,Revenue from Contracts with Customers - Identifying Performance Obligations and Licensing, respectively, which further clarify the guidance related to those specific topics within ASU 2014-09. In May 2016, the FASB issued ASU 2016-12,Revenue from Contracts with Customers - Narrow Scope Improvements and Practical Expedients, to reduce the risk of diversity in practice for certain aspects in ASU 2014-09, including collectibility, noncash consideration, presentation of sales tax and transition. Additionally, in December 2016, the FASB issued ASU 2016-20,Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. ASU 2016-20 makes minor corrections or minor improvements to the standard that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. The Company has made progress in its evaluation of the amended guidance, including identification of revenue streams. The Company recognizes revenue from product sales at the time of shipment and passage of title and risk of loss and control of the goods is transferred to the customer. The Company has no acceptance or other post-shipment obligations and does not offer product warranties or services to its customers. Although the Company is continuing to assess the impact of the amended guidance, Aceto generally anticipates that the timing of recognition of revenue will be substantially unchanged under the amended guidance. The amended guidance will be effective for Aceto in the first quarter of fiscal 2019 and permits adoption under either the full retrospective approach (recognize effects of the amended guidance in each prior reporting period presented) or the modified retrospective approach (recognize the cumulative effect of adoption as an adjustment to retained earnings at the date of initial application). The Company anticipates adopting this amended standard on a modified retrospective basis.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market Risk Sensitive Instruments
The market risk inherent in our market-risk-sensitive instruments and positions is the potential loss arising from adverse changes in investment market prices, foreign currency exchange-rates and interest rates.
Investment Market Price Risk
We had short-term investments of $3,059 at March 31, 2018 and $2,046 at June 30, 2017. Those short-term investments consisted of time deposits. Time deposits are short-term in nature and are accordingly valued at cost plus accrued interest, which approximates fair value.
Foreign Currency Exchange Risk
In order to reduce the risk of foreign currency exchange rate fluctuations, we hedge some of our transactions denominated in a currency other than the functional currencies applicable to each of our various entities. The instruments used for hedging are short-term foreign currency contracts (futures). The changes in market value of such contracts have a high correlation to price changes in the currency of the related hedged transactions. At March 31, 2018, we had foreign currency contracts outstanding that had a notional amount of $62,350. At June 30, 2017 our outstanding foreign currency contracts had a notional amount of $62,187. The difference between the fair market value of the foreign currency contracts and the related commitments at inception and the fair market value of the contracts and the related commitments at March 31, 2018 was not material.
We are subject to risk from changes in foreign exchange rates for our subsidiaries that use a foreign currency as their functional currency and are translated into U.S. dollars. These changes result in cumulative translation adjustments, which are included in accumulated other comprehensive loss. On March 31, 2018, we had translation exposure to various foreign currencies, with the most significant being the Euro. The potential loss as of March 31, 2018, resulting from a hypothetical 10% adverse change in quoted foreign currency exchange rates amounted to $6,588. On June 30, 2017 such potential loss amounted to $8,869. Actual results may differ.
Interest rate risk
Due to our financing, investing and cash-management activities, we are subject to market risk from exposure to changes in interest rates. We utilize a balanced mix of debt maturities along with both fixed-rate and variable-rate debt to manage our exposure to changes in interest rates. Our financial instrument holdings were analyzed to determine their sensitivity to interest rate changes. In this sensitivity analysis, we used the same change in interest rate for all maturities. All other factors were held constant. If there were an adverse change in interest rates of 10%, the expected effect on net income related to our financial instruments would be immaterial. However, there can be no assurances that interest rates will not significantly affect our results of operations.
In conjunction with the Company’s credit facilities, the Company entered into an interest rate swap on March 21, 2017 for an additional interest cost of 2.005% on a notional amount of $100,000, which has been designated as a cash flow hedge. The expiration date of this interest rate swap is December 21, 2021. The remaining notional balance of this derivative as of March 31, 2018 is $87,500. The unrealized gain to date associated with this derivative, which is recorded in accumulated other comprehensive income in the consolidated balance sheet at March 31, 2018, is $1,539.
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Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are designed to provide reasonable assurance that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Our disclosure controls and procedures are also designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officer, to allow timely decisions regarding required disclosure. Our chief executive officer and chief financial officer, with assistance from other members of our management, have reviewed the effectiveness of our disclosure controls and procedures as of March 31, 2018, the end of the period covered by this report. Previously, based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective as of March 31, 2018. However, due to the material weakness in internal control over financial reporting described below, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were not effective as of March 31, 2018.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company's annual or interim financial statements will not be prevented or detected on a timely basis. In completing our work with respect to the condensed consolidated financial statements presented in this report, weevaluated the deficiencies in our internal controls over financial reporting and determined that our internal control over financial reporting was not effective due to a material weakness in our controls over income tax accounting. Specifically, the execution of the controls over the application of the accounting literature to the measurement of deferred taxes did not operate effectively in relation to the assessment of the realizability of our deferred tax assets, and the need for a valuation allowance.
Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during our fiscal quarter ended March 31, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
As previously described in our 2017 10-K, we are subject to various environmental proceedings for which there were no material changes during the nine months ended March 31, 2018.
The Company incorporates by reference into this Item 1 the disclosures made with respect to pending legal proceedings set forth in Note 8 (Commitments, Contingencies and Other Matters) and Note 13 (Subsequent Events) to the Company’s Condensed Consolidated Financial Statements presented elsewhere herein.
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In addition to the other information discussed in this report, the factors described in Part I, Item 1A. “Risk Factors” in our 2017 Annual Report on Form 10-K for the fiscal year ended June 30, 2017, as amended, should be considered as they could materially adversely affect our business, financial condition, liquidity or future results.
The risk factors set forth below update and, to the extent inconsistent, supersede the risk factors associated with our business previously disclosed in Part I, Item 1A. "Risk Factors" in our 2017 Annual Report on Form 10-K for the fiscal year ended June 30, 2017, as amended.
The risk factors identified by the Company in this and other filings may not describe all of the risks facing our company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may adversely affect our business, financial condition or operating results.
The material impairment charge that we recorded as of March 31, 2018 was based on several adverse factors, certain of which could materially adversely impact the Company in subsequent fiscal quarters.
In the third quarter of fiscal 2018, we recorded impairment charges for goodwill and intangible assets of $256,266, all of which related to the Rising Pharmaceuticals reporting unit which is part of the Human Health segment. During the third quarter of fiscal 2018, our Rising Pharmaceuticals reporting unit had a decline in actual and forecasted revenue and earnings due to the persistent adverse conditions in the generics market. In addition, the U.S. government made a determination (which we are appealing) that 11 generic drug products we acquired through our Acetris Health subsidiary (part of the Rising Pharmaceuticals reporting unit) in a product purchase agreement with Lucid are not in compliance with the TAA country-of-origin provisions of a clause contained in the government supply contracts acquired from Lucid. As a result of the foregoing, we conducted an impairment test and recognized a significant goodwill and intangible asset impairment charge.
Many of the market and industry factors that led to the March 31, 2018 impairment charges could continue to impact us in future fiscal periods. Such factors could materially and adversely impact ourbusiness, financial condition, results of operations, liquidity and cash flows and could lead to additional impairment charges in the future.
We have been named in legal proceedings alleging securities law violations, which could be expensive and could divert our management’s attention. There may be additional class action and/or derivative claims filed in the future.
We and certain of our former and current executive officers have been named as defendants in securities actions filed in the United States District Court for the Eastern District of New York. While we plan to vigorously defend these actions, we may be unable to defend or settle these claims on favorable terms, and there can be no assurance that additional claims will not be made by other stockholders, or stockholders as a class. We expect to incur significant expenses associated with the defense of the pending and any future securities laws claims or derivative suits (including, without limitation, substantial attorneys’ fees and other fees of professional advisors and potential obligations to indemnify individuals who are or may become parties to such actions). An adverse determination, if one were to occur, could harm our reputation and have a material and negative affect on our business. We currently maintain “directors and officers” insurance policies; however, our insurance coverage may not be adequate or available for us to avoid or limit our exposure in the pending actions or in future claims and adequate insurance coverage may not be available in sufficient amounts or at a reasonable cost in the future. Additionally, securities and derivative claims may divert our management’s attention from other business concerns, which could seriously harm our business, financial condition, results of operations, liquidity and cash flows.
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We were not in compliance with certain covenants under our A&R Credit Facility as of March 31, 2018 and, although a waiver was obtained with respect to such non-compliance, in the event we are in violation of such covenants for subsequent periods, and we are unable to obtain a waiver, our business, financial condition, results of operations, liquidity and cash flows could be materially and adversely affected.
As of March 31, 2018, we were not in compliance with financial covenants under our A&R Credit Facility related to the maximum total net leverage ratio and the minimum debt service coverage ratio. On May 3, 2018, we entered into a Second Amendment and Waiver to the A&R Credit Agreement (the “2018 Amendment”). The 2018 Amendment, among other things, contains a waiver of any event of default under the A&R Credit Agreement arising as a result of our non-compliance with the Total Net Leverage Ratio and Debt Service Coverage Ratio financial covenants, in each case, solely for the fiscal quarter ended March 31, 2018. We could again be in breach of these covenants or other covenants with respect to subsequent periods while our credit facility remains outstanding. In the event of any future breach and resulting default, there is no guarantee that we could obtain an additional waiver on satisfactory terms, or at all, and any such waiver could result in higher borrowing costs and/or more restrictive covenants in future periods. Our failure to comply with these covenants or others could result in a default that, if not cured or waived, could result in our outstanding indebtedness becoming immediately due and payable, which in turn would have a material and adverse effect on our business, financial condition, results of operations, liquidity and cash flows.
In addition, during the period commencing on the closing of the 2018 Amendment and ending on the date we demonstrate compliance with each financial covenant set forth in the A&R Credit Agreement, the 2018 Amendment also amends the A&R Credit Facility to, among other things, restrict the incurrence of certain indebtedness, limit our ability to pay dividends, limit acquisitions and other investments and imposes certain other restrictions. Such restrictions limit our flexibility and thus couldhave a material and adverse effect on our business, financial condition, results of operations, liquidity and cash flows.
Because the waiver that we have received does not extend to fiscal periods beyond March 31, 2018 and because it is probable that we will not comply with certain financial covenants as of June 30, 2018 in the absence of a material change in our operating results, it was necessary for us to reclassify indebtedness under our credit facility, which lowered our working capital significantly as compared with our working capital as of December 31, 2017. Our ability to access the capital markets may be adversely affected by the additional restrictions contained in the 2018 Amendment and the reduction to our working capital, and we may be subject to higher borrowing costs, or, in some cases, unable to obtain financing on terms that are acceptable to us. If adequate funds are not available to us, or are not available on acceptable terms, we may not have sufficient liquidity to fund our operations,make future investments, take advantage of acquisitions or other opportunities, or respond to competitive challenges and this, in turn, could materially adversely affect our ability to advance our strategic plans.
We have experienced turnover in our senior management, and the loss of key personnel or an ability to attract, retain and motivate qualified personnel may result in operational inefficiencies that could negatively affect our business.
Our success depends upon the continued service of our talented management, as well as our key operational and technical employees, as well as upon our ability to continue to attract additional highly qualified personnel. We have recently experienced significant turnover in our senior management. In October 2017, William C. Kennally III replaced Salvatore Guccione as our chief executive officer. In October 2017, our chief financial officer, Douglas Roth, announced that he was retiring. He was replaced by Edward J. Borkowski, who served only briefly before accepting employment elsewhere. We have named Rebecca Roof to serve as our interim chief financial officer at a cost of two hundred fifty thousand dollars per month, payable to Ms. Roof’s employer AP Services LLC, an affiliate of AlixPartners LLP. In light of the significant challenges we are facing, we have also retained financial advisors to assist us at considerable expense.
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Our business may be adversely affected if we encounter complications in connection with the upgrade and implementation of our enterprise resource planning (“ERP”) system, our information technology systems and infrastructure. Upgrading and integrating our business systems could result in implementation issues and business disruptions.
In recent years, we have implemented or planned implementations of a new ERP system at all our global locations. The implementation of a new ERP system at our Rising subsidiary is scheduled to commence during May 2018. In general, the process of planning and preparing for these types of implementations is extremely complex and we will be required to address a number of challenges, including data conversion, system cutover and user training during the Rising implementation. Problems in any of these areas could cause operational problems during implementation, including delayed shipments, missed sales, billing and accounting errors and other operational issues. While we have invested significantly in the operation and protection of data and information technology, there can be no assurance that our efforts will prevent service interruptions, or identify breaches in our systems. Prolonged interruptions or significant breaches could materially adversely affect our business, financial condition, operating results and cash flows.In addition, in automating processes that heretofore have been undertaken manually, we may be required to reassess certain of our estimates, especially with respect to our rebates, returns and chargebacks approaches.
Our business, products or product pricing could be subject to negative publicity arising from the subpoena we recently received, which could have a material adverse effect on our business, financial position, results of operations, liquidity and cash flows.
In recent years, the generic pharmaceutical industry has been the subject of significant publicity regarding the pricing of pharmaceutical products, including publicity and pressure resulting from prices charged by competitors and peer companies for new products as well as price increases by competitors and peer companies on older products that the public has deemed excessive. Any downward pricing pressure on the price of our products arising from social or political pressure to lower the cost of pharmaceutical products could have a material adverse impact on our business, financial position, results of operations, liquidity and cash flows.
Accompanying the press and media coverage of pharmaceutical pricing practices and public complaints about the same, there has been increasing U.S. federal and state legislative and enforcement interest with respect to drug pricing. For instance, the United States Department of Justice has issued subpoenas to pharmaceutical companies, including us, seeking information about the sales, marketing and pricing of certain generic drugs. In addition to the effects of any investigations or claims brought against us, our business, financial position, results of operations, liquidity and cash flows could also be materially adversely affected if any such inquiries, of us or of other pharmaceutical companies or the industry more generally, were to result in legislative or regulatory proposals that limit our ability to increase the prices of our products.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not Applicable.
Item 3. Defaults Upon Senior Securities
Not Applicable.
Item 4. Mine Safety Disclosures
Not Applicable.
On May 3, 2018, the Company entered into a Second Amendment and Waiver to Second Amended and Restated Credit Agreement (the “Amendment”), by and among the Company, certain other loan parties party thereto (the “Loan Parties”), the lenders party thereto, and Wells Fargo Bank, National Association, as administrative agent (the “Administrative Agent”), which amended that certain Second Amended and Restated Credit Agreement, dated as of December 21, 2016, by and among the Company, the Loan Parties, the lenders party thereto and the Administrative Agent (as amended by that certain First Amendment to Second Amended and Restated Credit Agreement, dated as of December 13, 2017, the “A&R Credit Agreement”).
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The Amendment, among other things, contains a waiver of any event of default under the A&R Credit Agreement arising as a result of the non-compliance by the Company with the Total Net Leverage Ratio and Debt Service Coverage Ratio financial covenants, in each case, solely for the fiscal quarter ended March 31, 2018. The Amendment also contains several amendments to the A&R Credit Agreement including, among other things, (a) reducing the available revolving commitment thereunder to $100,000,000, and (b) during the period commencing on the closing of the Amendment and ending on the date the Company demonstrates compliance with each financial covenant set forth in the A&R Credit Agreement for the fiscal quarter ending June 30, 2018 (the “Limitation Period”; provided that if the Company is not in compliance with any of the financial covenants set forth in the A&R Credit Agreement for the fiscal quarter ending June 30, 2018, then the Limitation Period shall continue indefinitely): (i) fixing the applicable margin with respect to all loans under the A&R Credit Agreement to the highest level provided under the A&R Credit Agreement, which is 1.50% in the case of ABR Loans (as defined in the A&R Credit Agreement) and 2.50% in the case of Eurodollar Loans (as defined in the A&R Credit Agreement), (ii) fixing the commitment fee on the undrawn revolving commitments under the A&R Credit Agreement to the highest level provided under the A&R Credit Agreement which is 0.40% per annum, (iii) requiring the prior written consent of the Required Lenders (as defined in the A&R Credit Agreement) as a condition precedent to the lenders extending any Loans (as defined in the A&R Credit Agreement) or the issuing banks issuing, amending, renewing or extending any Letter of Credit (as defined in the A&R Credit Agreement), (iv) restricting the amount of dividends or distributions the Company may make to its shareholders to no more than $0.01 per share for the fiscal quarter ending on June 30, 2018 and, during the Limitation Period, restricting the Company from making any other dividends or distributions to its shareholders thereafter and (v) restricting the incurrence of certain indebtedness, limiting acquisitions and other investments and imposing certain other restrictions.
The foregoing description of the Amendment is a summary only, and is qualified in its entirety by reference to the complete text thereof, a copy of which is attached as Exhibit 10.3 to this Quarterly Report on Form 10-Q, and which is incorporated herein.
| Item 6. | Exhibits |
| 15.1 | Letter from BDO USA, LLP regarding unaudited interim financial information |
| 31.1 | Certifications of Principal Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2 | Certifications of Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32.1* | Certifications of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2* | Certifications of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 101.INS | XBRL Instance Document |
| 101.SCH | XBRL Taxonomy Extension Schema Document |
| 101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document |
| 101.DEF | XBRL Taxonomy Extension Definition Linkbase Document |
| 101.LAB | XBRL Taxonomy Extension Label Linkbase Document |
| 101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document |
*Furnished, not filed
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| ACETO CORPORATION | ||||
| DATE | October 12, 2018 | BY | /s/ William C. Kennally, III | |
| William C. Kennally, President and Chief Executive Officer | ||||
| (Principal Executive Officer) | ||||
| DATE | October 12, 2018 | BY | /s/ Rebecca Roof | |
| Rebecca Roof, Interim Chief Financial Officer | ||||
| (Principal Financial Officer) | ||||
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